By Sebastian Boyd and Nathan Gill

March 5 (Bloomberg) — Chilean economic activity shrank by the most in almost a decade in January, fueling expectations that policy makers next week will cut interest rates for the third time this year.

    

The economy contracted 1.4 percent in January from the same month a year earlier, the central bank reported on its Web site, in line with the median forecast of 22 economists surveyed by Bloomberg for a 1.6 percent contraction. The economy last shrank more in July 1999.

    

Chile’s economy is slowing on lower consumer spending and declining demand for its exports. The central bank already lowered interest rates by 3.5 percentage points this year and the government in January announced a $4 billion package of tax breaks and subsidies to boost domestic demand.

    

Growth was “quite a lot lower than we expected,” said Mario Gonzalez, an economist at Banco BCI SA’s brokerage unit in Santiago. “We will probably see an acceleration of monetary policy. Monetary policy is going to remain extremely expansive and we could see another fiscal stimulus package.”

    

Chilean policy makers last month voted 4-to-1 to cut the overnight rate by 2.5 percentage points to 4.75 percent, according to the minutes of the Feb. 12 meeting posted today on the central bank’s Web site.

    

The economic activity report today was “obviously not good, but it wasn’t a surprise either,” Finance Minister Andres Velasco said. “There is a crisis in the world economy, and as we have seen for some months now, Chile is not immune.”

                          Rates, Demand

Central bank commission member Sebastian Claro voted for a 2-point cut, his second dissenting vote since joining the board in December 2007.

    

Economists expect the bank to lower the benchmark rate by 1.5 percentage points to 3.25 percent at its March 12 meeting, according to the median of seven forecasts compiled by Bloomberg.

    

The bank reduced the benchmark rate by 1 percentage point in January. Policy makers last year pushed borrowing costs up to a decade high of 8.25 percent in a bid to brake inflation.

     Consumer prices fell 0.4 percent in February, the fourth straight decline, the national statistics institute said today.

    

Economists expected a 0.1 percent decline, according to the median of 22 forecasts. The annual inflation rate fell to 5.5 percent, the lowest since 2007.

    

“This data increases the chance of a rate cut,” said Flavio Magnasco, an economist at Banco Falabella SA in Santiago. “According to the central bank’s estimates the thing that will help us avoid a recession is demand, and demand has braked quite hard, so I think we’ll see a recession by year-end.”

                        Core, Stabilizing

The annual pace of underlying inflation, which excludes fuel, vegetables and fresh fruit, slowed to 6.7 percent as prices declined 0.3 percent from the previous month, the statistics institute said.

    

Chilean consumers’ monthly financial services bill fell 41 percent during February, and food prices declined 1.8 percent.

    

The financial services segment of the consumer-price index measures costs associated with opening and closing bank accounts or taking out a mortgage.

    

Central bank chief economist Pablo Garcia, in an interview from his office in Santiago today, said the country’s economy is showing signs of stabilizing in the first quarter after imports and durable goods sales tumbled at the end of last year.

                             Rebound

The government’s decision to draw upon some of its $19.5 billion stabilization fund stockpiled during the 2002-2007 rally in copper, the country’s biggest export, to help address slowing economic growth has boosted senior officials’ approval ratings.

    

President Michelle Bachelet’s approval rating surged last month to 58.5 percent, the highest since April 2006, according to a poll published today by Santiago-based Adimark Gfk.

    

Velasco’s popularity also rose, giving him a 53 percent approval rating, after Bachelet and Velasco announced the $4 billion package of tax breaks and subsidies to stimulate demand in Chile’s slowing economy. Bachelet took office in March 2006.

    

Adimark polled 1,017 adults between Feb. 2 and Feb. 28. The poll has a margin of error of 3 percent and a 95 percent confidence level.

    

The peso weakened 0.3 percent to 610.30 per dollar at 12:59 p.m. New York time from 610.45 yesterday.