Nov. 12 (Bloomberg) -- Chile’s central bank kept its benchmark interest rate at 0.5 percent and announced plans to scale back cheap loans to commercial banks.

Private banks can borrow at the record-low overnight rate for 150 days under the rules issued today, down from a previous limit of 180 days. The central bank will reduce the length of loans each month until ending the program in May.

Reducing the length of the loans allows the bank the option of raising the benchmark rate sooner. The bank said today the benchmark rate will “remain at its minimum level of 0.5 percent for a prolonged period, which will extend until at least the second quarter of next year.”

“This doesn’t preclude them from raising rates earlier, but it would make more sense to wait until the facility’s removed and do it in May or June,” said Jimena Zuniga, an economist at Barclays Capital in New York. “This shifts the balance of risks to a later date than our April baseline.”

Today’s interest-rate decision was in line with the unanimous forecast of 20 economists surveyed by Bloomberg.

Chile’s economy shrank in the first three quarters of 2009 from the same period a year earlier after weaker global demand depressed prices for exports, led by copper. The central bank slashed interest rates by 7.75 percentage points in the first seven months of the year as consumer spending slumped and prices fell.

The central bank raised the benchmark rate to 8.25 percent last year as increasing food and fuel prices pushed annual inflation to a 14-year high of 9.9 percent.

Economic Data

Consumer prices in Chile declined 1.9 percent in October from a year earlier, the biggest drop since 1934, according to data from the National Statistics Institute. The underlying price index, which excludes changes in the price of fresh food and fuel, fell 0.4 percent during the same period.

Economic activity dropped 1.1 percent in September from a year earlier and 0.33 percent from August, ending a four-month expansion, according to central bank data.

“September’s activity numbers were slightly disappointing and supported the dovish tone of the central bank,” said Alejandro Cuadrado, an economist at Bank of America Merrill Lynch in New York. “Inflation probably touched bottom in October, but minus 2 percent is still not a very compelling reason for a central bank to raise rates.”

Currency’s Performance

Chile’s peso has strengthened 9.2 percent over the past month, the best performer during that period of all 176 currencies tracked by Bloomberg. A stronger currency helps lower the cost of imports, relieves pressure on prices and may allow the central bank to keep interest-rates low, according to members of Chile’s Monetary Policy Group, a team of five economists that monitors the central bank’s decisions.

“The peso has appreciated in recent weeks and as long as that continues, it creates space for the central bank to delay the beginning of normalization of the rate,” said Alejandro Fernandez, an economist at Gemines Consultores SA in Santiago. “There is probably still room for the dollar to keep falling and that is one relevant factor that explains our recommendation for maintaining the rate still.”

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

Last Updated: November 12, 2009 17:20 EST