Aug. 23 (Bloomberg) -- Bank of Japan Governor Toshihiko Fukui said keeping interest rates too low may spur risky investment, signaling the central bank still intends to raise borrowing costs even after the global credit rout.

``Distortions and the misallocation of resources could occur if interest rates are kept at levels inconsistent with the economy,'' Fukui told reporters in Tokyo today after his board kept interest rates on hold. ``Our policy is forward-looking and we can act when we're confident in our judgment.''

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's comments indicate he may resume his policy of gradually increasing borrowing costs later this year.

``Fukui's comments today make it pretty clear he's still committed to raising rates,'' said Teizo Taya, former Bank of Japan policy maker and now special adviser to Daiwa Institute of Research Ltd.

The central bank held its key rate at 0.5 percent in an 8-1 vote. Board member Atsushi Mizuno was the sole dissenter for a second straight meeting, proposing a rate increase.

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

Sustainable Growth

``It's highly likely that the Japanese economy will achieve sustainable growth with stable prices,'' Fukui said, repeating last month's assessment. ``However, we'll examine upcoming data and financial-market movements at home and abroad and will make an appropriate policy judgment.''

The yen fell as much as 1.6 percent against the dollar, the most since January 2005, as gains in stocks gave investors confidence to borrow in Japan to buy riskier assets elsewhere. Japan's currency traded at 116.66 per dollar at 11:56 a.m. in London from 115.34 late yesterday in New York.

The yield on Japan's 10-year bond rose 1.5 basis points to 1.595 percent. Forty-three of 46 economists surveyed by Bloomberg News this week predicted today's decision.

``If stability returns in coming weeks, then the BOJ will probably feel comfortable to raise rates in a month,'' said Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo.

Japan's key rate is the lowest among major economies. Fukui 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.

`Repricing' Process

Fukui described the tumult as a ``repricing'' process and said investors are adjusting from a ``too-loose'' judgment of risk. He said the bank will watch whether the correction is orderly and whether the moves will affect economic growth.

``It's not the type of problem that will go away in a few weeks,'' Fukui said.

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

Fukui said the bank isn't influenced by the policy judgment of other central banks. Each monetary authority views the prospects for growth and prices in its own economy, he said.

``Although Fukui denied the BOJ's policy should be simply affected by other central banks, it's not realistic to expect a BOJ rate hike when the Fed's cutting rates,'' said Tomoko Fujii, senior economist and strategist at Bank of America N.A. in Tokyo.

Next Meeting

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.

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.

Japanese Finance Minister Koji Omi said the worst of the subprime issue is probably over. The Bank of Japan made an appropriate decision today, he said in Osaka.

This month's turmoil helped Japan's currency strengthen as investors sold risky assets and dumped shares. The Nikkei 225 Stock Average has lost more than 5 percent in August so far.

Stocks, Yen

``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 Ben Eldred, an economist at Daiwa Securities SMBC in London.

Fukui said the central bank's policy needs to dissuade investors from making one-sided bets in the currency market. Still, he maintained that monetary policy is based on an analysis of the economy and prices.

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.

Recent economic data 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.

To contact the reporters on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net; Lily Nonomiya in Tokyo at lnonomiya@bloomberg.net

Last Updated: August 23, 2007 06:58 EDT