"The weakness in activity and demand, both consumer spending and investment, has been greater than anticipated," the bank said in the report. "Expectations for investment and consumer spending have deteriorated notably, especially in the last few months."
Chile's government has cut its 2014 growth forecast twice this year to 3.2 percent, citing a steep slowdown in domestic demand. The government of former President Sebastian Pinera, which left office in March, had forecast growth of 4.9 percent.
"The strong reduction in growth is, without doubt, worrying news that should move all sectors, politicians and economists, to redouble their efforts to return the dynamism to the Chilean economy," central bank President Rodrigo Vergara said in a copy of a speech to lawmakers Wednesday.
The bank cut its estimate for potential growth, the fastest pace at which the economy can expand without fueling inflation, to between 4 percent and 4.5 percent from a previous calculation of about 5 percent. Policymakers cited the probability of slower investment and total productivity growth for the reduction as the economy develops.
"The slower dynamism in the economy will be more persistent than previously forecast," policymakers said. "The recovery, although moderate, is based on greater monetary impulse, lower market rates, more fiscal stimulus, the growth of commercial partners, the depreciation of the peso and an improvement in private expectations."
Finance Minister Alberto Arenas said last week that the economic slowdown has been longer and deeper than previously forecast, and called for a private and public alliance to help reactivate growth. On Sept. 1, President Michelle Bachelet announced an extra $500 million in investment this year which will come from speeding up current investment plans and tax changes.
The central bank raised its estimate for the average price of copper this year to $3.15 per pound from $3.1. Chile is the world´s largest copper producer and the metal represents more than half of the country´s exports.
Policymakers forecast investment will decline 4.1 percent this year, compared with their previous estimate of a 0.7 percent drop. Their forecast for total domestic demand growth was reduced to 0.1 percent from 1.7 percent in June.
"The bigger news come from activity and internal spending, that have performed significantly worse than forecast," the bank said in the report. "The poor performance of spending reached all its components."
Manufacturing output fell 4.1 percent in July, exceeding analyst expectations, while retail sales rose 1.5 percent, the least since 2009, fueling forecasts for further interest rate cuts.
As growth slows and the central bank cuts rates, the peso has declined, pushing the inflation rate to 4.5 percent in July, above the bank´s 2 percent to 4 percent target range for the fourth straight month. The peso has fallen 13.5 percent against the dollar in the past year, the worst performing emerging market currency after the Argentine peso.
Policymakers said today that recent inflation numbers have been in line with expectations and forecast a slowdown next year. The weaker performance of the economy is already having effects on prices, they said.
"Inflation will remain above 4 percent in what is left of 2014," policymakers said in the report. "In 2015, it will rapidly slow toward 3 percent."