Aug. 25 (Bloomberg) -- Chile's economy expanded faster than expected in the second quarter, giving the central bank room to raise interest rates to stem inflation.

Chile's gross domestic product grew 4.3 percent in the second quarter, up from a revised 3.3 percent in the first quarter, the Santiago-based central bank said on its Web site today. Growth exceeded the median estimate of 3.96 percent in a Bloomberg survey of 12 economists.

The faster-than-expected growth was driven by an 11 percent increase in demand, suggesting policy makers can raise interest rates further without bringing the economy to a standstill. The central bank has raised its overnight rate by 1.25 percentage points to a nine-year high of 7.75 percent this year in an effort to bring down the highest inflation rate since 1994.

Growing consumption shows ``why monetary policy must retain its tightening bias and why we think further hikes lie ahead,'' Rafael de la Fuente, senior Latin American economist at BNP Paribas SA in New York, wrote today in a note to clients.

The central bank lifted interest rates by half a percentage point at each of its last two monthly meetings, and will probably carry out a quarter-point increase at its Sept. 4 meeting, according to the median estimate of five analysts in a Bloomberg survey.

Demand Focus

Private consumption grew 5.9 percent in the second quarter, as Chileans spent 15 percent more, in real terms, on durable goods. Fixed capital, or assets, expanded 23 percent from a year earlier in the second quarter, led by investment in machinery and equipment, according to the central bank.

``The buoyancy of domestic demand, particularly investment spending, fully justifies the recent more decisive central bank inflation fighting stance,'' Goldman Sachs Group Inc. economist Alberto Ramos wrote to clients today. ``The central bank should continue to focus exclusively on fighting inflation.''

Chile companies plan to invest more than $57 billion, about a third of the country's annual gross domestic product, by the end of 2012, Finance Minister Andres Velasco said today. Record investment will help improve productivity, and foster economic expansion without generating inflation, he said.

The economy may accelerate in the second half of 2008, Velasco said at a conference of small business owners in Santiago today.

``There are more than enough reasons to suppose that, just as in the second quarter of the year we grew more than in the first, in the third quarter we will grow more than in the second,'' he said. ``Things will be better in the second half.''

`Wrong Track'

Rain has filled dams, permitting greater use of cleaner and cheaper hydroelectric power while reducing Chile's reliance on burning expensive diesel to drive turbines, Velasco said.

Yields on inflation-linked Chilean government bonds rose on Aug. 22 after Velasco announced a 22 percent cut in fuel taxes to help slow price increases, according to Ricardo Gomez, head of fixed income at Larrain Vial SA in Santiago.

The fuel tax cuts may lower annual inflation by a quarter point in the month they come into force, Velasco said.

Inflation is ``too high,'' Velasco said today. ``We will all work -- in the government, the central bank, businessmen and congress -- we will work to lower inflation.''

Consumer prices will probably rise 1 percent in August, according to the median estimate of five economists in a Bloomberg survey. Annual inflation may have slowed to 9.4 percent from 9.5 percent in July.

Velasco's measures are ``too little, too late,'' Adolfo Zaldivar, president of Chile's Senate said today, blaming price rises on a lack of political will. ``Things aren't going well and we're on the wrong track,'' said Zaldivar, who called in July for Velasco to be fired.

To contact the reporter on this story: Sebastian Boyd in Santiago at sboyd9@bloomberg.net

Last Updated: August 25, 2008 14:23 EDT