June 15 (Bloomberg) -- The Bank of Japan kept its key interest rate near zero percent and Governor Toshihiko Fukui said the bank will monitor the effect of falling stocks on the world's second-biggest economy.

The decision by the nine-member board, which signaled in March it was preparing to raise rates, was unanimous, the bank said in Tokyo today. Fukui said he will complete his term, rebuffing calls to step down after disclosing he invested in a fund whose founder was arrested last week for insider trading.

A 19 percent drop in the Nikkei 225 Stock Average in the past seven weeks dented the central bank's case that the economy is ready for higher borrowing costs. The controversy over Fukui's investments also fueled speculation that he will hold off on raising rates, sustaining a rally in government bonds.

If the stock market ``stabilizes and all indicators remain in good shape it is likely they'll raise rates in July,'' said Masaaki Kanno, chief economist at JP Morgan Securities in Tokyo. ``If not, then they don't have to rush.''

Kanno, a former senior adviser at the central bank, forecasts a rate increase between July and September, and another one by the end of the year. All 15 economists surveyed by Bloomberg News forecast the bank would leave rates unchanged today.

The European Central Bank, the Bank of Korea, the Reserve Bank of India and the Reserve Bank of South Africa all raised interest rates last week. At least seven officials from the U.S. Federal Reserve, which next meets June 28-29, have said in the past two weeks they're concerned about inflation in the world's largest economy.

Tankan Survey

The Nikkei 225 rose 1.1 percent to 14,470.76 at the 3 p.m. close in Tokyo. It has gained 1.8 percent since June 13, when it sank to its lowest since Oct. 31. The Morgan Stanley Capital International World Index has fallen 10 percent since setting a six-year high on May 9.

``Stock prices are a major economic indicator that lead economic and price activity,'' Fukui said. ``We will continue to monitor their impact on the overall economy, as they can affect both corporate and household sentiment.''

The bank will get an indication of how much stock-price drops have affected business confidence in the quarterly Tankan business confidence survey to be published on July 3. The Tankan is Japan's most widely watched business confidence indicator.

Japan's benchmark bond futures gained for a fourth day, rising 0.03 to 133.23, as investors scaled back bets that the central bank will raise interest rates as soon as next month.

``Conditions aren't right for the central bank to raise rates,'' said Shinji Hiramatsu, a fund manager in Tokyo who helps oversee the equivalent of about $6.1 billion at Sompo Japan Asset Management Co. ``Fukui's scandal is creating uncertainty over the course of monetary policy.''

Murakami Fund

Nine of the economists surveyed by Bloomberg News between June 8 and June 12 had expected the bank to raise rates as early as July. Some of those economists pushed back their forecasts after Fukui on June 13 told parliament that he owns shares in Yoshiaki Murakami's fund.

``I started to realize that Murakami no longer had the same aspirations for the fund he began with,'' Fukui, 70, told a parliamentary committee today. He said he didn't know in February that Murakami had broken any laws.

Lawmakers, some of whom say Fukui should resign, summoned the governor less than two hours after the central bank voted to keep interest rates unchanged. Prime Minister Junichiro Koizumi said after the testimony he has no plan to replace Fukui.

The yen traded at 114.94 per dollar at 6:11 p.m. in Tokyo from 114.92 before the announcement to keep rates on hold.

The longer the Bank of Japan waits before raising interest rates for the first time in almost six years the greater the risk that the nation's expansion will kindle inflation. The bank kept borrowing costs near zero percent to combat seven years of deflation, from which Japan is now emerging.

`Red Flag'

Core consumer prices, which exclude fresh food and which are the central bank's preferred measurement for inflation, rose 0.5 percent in each of this year's first four months. Consumer prices for May will be published on June 30.

Rising oil and metal costs pushed producer prices up 3.3 percent in May from a year earlier, the fastest pace in 25 years, the central bank said June 12.

``The report raises a red flag on building inflation pressures in Japan,'' said Jesper Koll, chief Japan economist at Merrill Lynch & Co. in Tokyo. ``If the Bank of Japan waits until the pass-though from rising corporate goods prices accelerates, it may no longer have the luxury of raising rates in a `measured pace'.''

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

Last Updated: June 15, 2006 06:23 EDT