Aug. 23 (Bloomberg) -- The Bank of Japan kept interest rates unchanged after a global credit rout clouded the outlook for growth in the world's second-largest economy.

Governor Toshihiko Fukui and his policy colleagues voted 8-1 to hold the key overnight lending rate at 0.5 percent, the central bank said in Tokyo today. The decision was predicted by economists. Board member Atsushi Mizuno, who proposed a rate increase in July, dissented.

Central banks in Japan, the U.S. and Europe injected more than $350 billion into the banking system this month after credit dried up following the collapse of the U.S. subprime mortgage market. Fukui, who has warned that leaving rates low could fuel risky investments and asset bubbles, may resume his policy of gradually increasing borrowing costs later this year.

``Recent financial market turmoil is unlikely to have altered the Bank of Japan's view that the economic case for another rate rise has been made,'' said Ben Eldred, an economist at Daiwa Securities SMBC Europe Ltd. in London. ``Monetary policy remains extremely accommodative.''

Investors see a 39 percent chance of a September rate increase, according to Credit Suisse Group calculations based on interest payments.

Japan's key lending rate is the lowest among industrialized economies. Fukui, who will hold a news conference at 3:30 p.m. in Tokyo, has said the bank needs to normalize policy now that the economy has overcome 15 years of stagnation that followed the bursting of a stock and property bubble in the early 1990s.

`Sooner the Better'

Reserve Bank of Australia Governor Glenn Stevens told his country's parliament on Aug. 17 that ``the sooner the Japanese interest rates are able to be normal again, the better from the point of view of the global financial system.''

The yen traded at 115.75 per dollar at 2:19 p.m. in Tokyo from 115.94 before the announcement. Japan's currency fell to a one-week low as gains in stocks gave investors confidence to borrow in Japan to buy riskier assets elsewhere.

The yield on Japan's 10-year bond rose half a basis point to 1.585 percent. Forty-three of 46 economists surveyed by Bloomberg News this week predicted today's decision.

The chance of a rate increase rose as high as 75 percent on Aug. 9. Earlier that week Fukui said keeping rates low for too long may cause the misallocation of resources. The probability slumped on Aug. 10 as the credit-market turmoil intensified.

ECB Still Vigilant

The U.S. Federal Reserve's Aug. 17 decision to cut the rate at which it lends to banks may also have made it difficult for the Bank of Japan to tighten credit today.

``A rate increase this time may have signaled a rift in major central banks' concerted efforts to alleviate investors' concerns and exacerbated market volatility,'' said Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Securities Co.

The European Central Bank yesterday added more funds to the banking system, while saying it would stay vigilant on inflation, prompting investors to raise bets of a Sept. 6 rate increase.

``The latest ECB statement lends support to the BOJ and somewhat increases the possibility of a September rate hike'' by the Bank of Japan, said Masuhisa Kobayashi, chief Japanese bond strategist at Barclays Capital in Tokyo.

Australia, Chile, China, Norway, South Africa and South Korea are among banks that raised borrowing costs over the past month, on the view that inflation remains a bigger threat to their economies than the fallout from the subprime-mortgage rout.

South Korea

South Korea's economic expansion is unlikely to falter following the U.S. loan crisis, Vice Finance Minister Lim Young Rok said today. Japan's Finance Minister Koji Omi said the worst of the subprime issue is probably over. He said the Bank of Japan made an appropriate decision today.

This month's tumult helped Japan's currency rebound to its highest level in more than a year as investors sold risky assets and dumped shares. The Nikkei 225 Stock Average has lost more than 5 percent in August so far.

``Against a backdrop of a weaker Nikkei and a stronger yen, it would have been all but impossible for the policy board to give serious consideration to a rate rise this month,'' said Daiwa SMBC's Eldred.

Until July 25, the yen had weakened against all 16 most- traded currencies this year as investors borrowed in Japan to buy higher-yielding assets overseas in so-called carry trades.

Japan's currency has risen 2.3 percent against the dollar and 3.3 percent versus the euro this month, hurting exporters as well as individuals who have bought assets in foreign currencies.

``A concern is that the yen's rise would hurt not only exporting companies but also Japanese consumers,'' said Masaaki Kanno, a former central bank official and now chief economist at JPMorgan Securities in Tokyo.

Margin Trading

JPMorgan estimates that foreign-currency losses from margin trading in the wake of the yen's surge may total between 200 billion yen ($1.7 billion) and 300 billion yen, or about 0.1 percent of disposable household incomes.

Recent economic data also failed to support a rate increase. Economic growth slowed to an annual 0.5 percent rate in the second quarter from 3.2 percent in the first three months. Consumer prices excluding fresh food fell 0.1 percent in June, a fifth monthly drop.

The central bank's next decision will be on Sept. 19, a day after the Federal Reserve holds its regular policy-setting meeting. Interest-rate futures show traders are betting the Fed will cut its key overnight lending rate on Sept. 18 or earlier.

A September rate increase ``has to be regarded as touch and go if markets remain unstable,'' said Tetsufumi Yamakawa, a former central bank official and now chief economist at Goldman Sachs Group Inc. in Tokyo. Yamakawa said the Fed's next move will influence the BOJ's decision.

The bank will release its monthly economic assessment at 3 p.m. in Tokyo.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

Last Updated: August 23, 2007 01:20 EDT