Oct. 31 (Bloomberg) -- The Bank of Japan cut its benchmark interest rate to 0.3 percent in a split decision to help stave off a prolonged recession.

Governor Masaaki Shirakawa cast the deciding vote to lower the key overnight lending rate from 0.5 percent after four of the eight board members dissented, the central bank said in Tokyo today. Three wanted to cut the rate to 0.25 percent, and one wanted to leave it unchanged, Shirakawa said.

Shirakawa, 59, came under pressure to lower borrowing costs for the first time in seven years after the Nikkei 225 Stock Average slumped to the lowest level since 1982 on concern that the global financial rout would deepen Japan's downturn. Until today, the bank had kept rates unchanged in the face of cuts by counterparts worldwide, arguing they were already ``very low.''

``A rate cut will probably do little to prop up the economy; nevertheless the bank was probably fearful they'd be viewed as clinging to an overly rigid stance in the middle of a global crisis'' if they didn't cut, said Teizo Taya, a former Bank of Japan board member who now advises the Daiwa Institute of Research. ``The dissenters may have wanted to indicate they weren't comfortable with pressure from the government.''

The yen rose to 97.17 per dollar at 4:16 p.m. in Tokyo, from 98.43 before the decision. Japan's currency climbed as high as 90.93 last week, the strongest in 13 years, threatening exporters' earnings. The Nikkei plunged 5 percent today, capping a record 24 percent monthly decline.

Bank's Forecasts

The central bank slashed its growth forecast for the year ending March to 0.1 percent from 1.2 percent predicted in July. The economy will expand 0.6 percent next fiscal year and 1.7 percent in the period starting April 2010, it said in a twice- yearly outlook published after the rate decision.

Inflation will diminish next fiscal year, the bank said. Core consumer prices will rise 1.6 percent in the current fiscal year and fail to increase in the following 12 months, it said. Prices will gain 0.3 percent in the year starting April 2010.

``Increased sluggishness in Japan's economic activity will likely remain over the next several quarters with exports leveling off and the effects of earlier increases in energy and materials prices persisting,'' the bank said in a statement.

Interest on Reserves

The central bank decided to begin paying interest on reserves commercial lenders hold at the bank to provide liquidity to the financial system. It also trimmed the Lombard rate, or the cost it charges for loans made directly to member banks, to 0.5 percent from 0.75 percent.

Speculation the Bank of Japan would cut rates was fueled by a Nikkei newspaper report on Oct. 29 that said policy makers were leaning toward a reduction. The chance the bank would halve its key rate rose to 60 percent today from 8 percent earlier this week, according to calculations by JPMorgan Chase & Co.

Fifteen of 17 economists surveyed by Bloomberg News predicted a reduction to 0.25 percent.

``Given the state of the economy and financial markets, this is the time to lower borrowing costs,'' said Naoki Iizuka, a senior economist at Mizuho Securities Co. in Tokyo. ``The yen has been weakening because investors already factored in a rate reduction, so it would be difficult for the BOJ to resist.''

The U.S. Federal Reserve cut its benchmark rate to a record-equaling 1 percent this week and China lowered borrowing costs for a third time in two months.

Faltering Economy

Evidence that the world's second-largest economy is faltering mounted in the past month as the global crisis deepened. Exports climbed 1.5 percent in September, less than half of what economists expected, and industrial production tumbled for a third quarter. Reports today showed inflation eased and household spending fell for a seventh month.

Companies are suffering as growth slows. Mizuho Financial Group Inc., Japan's second-biggest bank; All Nippon Airways Co., the largest domestic carrier; Suzuki Motor Corp., Japan's second-largest minicar maker; and Kawasaki Heavy Industries Ltd., the maker of Ninja racing bikes, all cut earnings forecasts today. Daiwa Securities Group Inc., the second-largest brokerage, posted an unexpected loss.

``The outlook for economic activity and prices is attended by increased downside risks to economic activity but also by decreased upside risks to inflation relative to the recent past,'' the central bank said.

Before today, Shirakawa and his board had given no indication they planned to cut borrowing costs, other than to say that policy was ``flexible.'' Even today, policy makers warned that ``from a longer-term perspective,'' keeping borrowing costs low for too long ``may lead to larger swings in economic and financial activity as well as in prices.''

Government Package

The BOJ said it will pay 0.1 percent on reserves lenders hold at the central bank. Paying interest would discourage lenders from hoarding cash and help the bank provide more funds without worrying about the overnight lending rate falling below its target rate. The Federal Reserve adopted the measure on Oct. 6.

The bank ``has undertaken various prompt and decisive measures in providing liquidity, bearing in mind that the most important contribution a central bank can make in this situation is to ensure stability in financial markets,'' it said today.

A rate reduction may provide some relief to Prime Minister Taro Aso, who yesterday unveiled a $51 billion economic stimulus package in a bid to minimize the effect of tumbling stock prices and the surging yen on the economy.

(Editor: Irene Lu)