The National Service of Geology and Mining said the explosion that sparked the eruption also produced a column of gas 10 kilometers (six miles) high, hours after warning of strong seismic activity in the area.
"You can see the fire (in the volcano) and a plume of smoke, and there's a strong smell of sulfur," top Los Rios region official Juan Andres Varas told reporters.
The government, which earlier ordered the evacuation of 600 people, expanded that number to 3,500 people to be relocated to shelters in safe areas. Authorities issued a red alert, the maximum warning level, for the area.
A border crossing between Argentina and Chile was closed.
A cloud of ash could be seen in the Patagonian resort town of Bariloche in Argentina, about 100 kilometers (62 miles) east of the volcano.
"We're trying to stop car traffic and ask that people stay at home and close their doors and windows to prevent the volcanic ash from coming in. The city's airport was also closed," Carlos Hidalgo, Bariloche's communications secretary, told TN television.
"Ash was dumped like a snowstorm... The city is covered in gray ash."
Nearby localities were also affected, said Hidalgo, whose city of 50,000 people welcomes thousands of foreign tourists each year to its lakes and mountain scenery.
Puyehue is located 870 kilometers (540 miles) south of the capital Santiago in the Cordon Caulle complex nestled in the Andes mountains. Its last major eruption was in 1960, following a magnitude 9.5 earthquake.
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