(Recasts lead, adds comments from central bank and economist, background)
By Anthony Esposito
SANTIAGO, Dec 5 (Reuters) - Chile's economy contracted for the first time in seven years in annual terms, as manufacturing and mining activity fell, potentially paving the way for the central bank to cut interest rates to spur growth.
Economic activity fell 0.4 percent in October from the year-earlier month, the first annual contraction since October 2009, central bank data showed on Monday.
The IMACEC economic activity index, encompassing about 90 percent of the economy tallied in gross domestic product figures, fell short of Reuters forecasts for 0.0 percent growth.
"It makes it more likely at the margin that the central bank will cut interest rates early next year ... it gives them a brief window in which they can easily justify reducing interest rates," said Adam Collins, Latin America economist at Capital Economics.
If yearly inflation stays below 3 percent, the midpoint of the central bank's target range, an interest rate cut could come as soon as January, said Collins.
Traders and analysts increasingly see the bank cutting its benchmark rate from its current 3.5 percent level as inflationary pressures have eased.
Monday's data showed that activity in the mining sector fell 7.1 percent from a year earlier, while non-mining activity rose 0.3 percent.
The service sector expanded but factory activity dropped.
The central bank also pointed out that there were two fewer working days in October 2016 versus a year earlier.
Chile's economy has been hampered as falling copper prices prompted a steep drop in mining investment.
Chile is the world's top producer of copper.
In comparison with September, economic activity in October decreased a seasonally adjusted 1.1 percent. (Reporting by Anthony Esposito Editing by W Simon)