“The Bank of Japan will gradually adjust the level of interest rates in accordance with the pace of improvements in the economy and prices and check risk factors,” Muto said at an annual meeting of Japanese credit cooperatives Friday in Tokyo.

Growth in Japan and worldwide will probably be sustained and the country’s prices will resume rising in the long term, Muto said. The International Monetary Fund this week warned Japan should keep borrowing costs on hold until deflation is stamped out and financial markets calm down.

“BOJ policy makers have said Japan’s domestic economy has been developing in line with the bank’s forecast, and there are no reasons for the Bank of Japan to keep putting off a rate hike in such circumstances,” said Hiroaki Muto, senior economist a Sumitomo Mitsui Asset Management Co. in Tokyo. “There’s still a chance for the BOJ to raise rates this year, probably in December.”

The central bank last week kept the benchmark overnight lending rate at 0.5 percent, the lowest in the industrialized world, as policy makers sought more time to assess the effect of the U.S. subprime mortgage crisis on global economic growth.

Eleven of 31 economists surveyed by Bloomberg News predict a rate increase by the end of 2007.

Deputy Governor Muto said Japan’s financial system is stable as a whole and the U.S. housing mortgage slump probably won’t have a big effect. He said it’s “highly probable” that the world economy will keep expanding because growth outside of the U.S. remains solid.

Still, Muto said, the central bank must keep a close watch on financial markets as well as the world economy. Markets remain volatile and there’s a degree of uncertainty in the global economy, including downside risks to U.S. growth, he said.

Governor Toshihiko Fukui said Thursday in Washington that problems stemming from the subprime crisis persist and have increased financial-market “uncertainty.”

“The time the housing market is taking to correct itself is cause for concern, and because this involves the financial markets, uncertainty is increasing a bit,” Fukui said after meeting with U.S. Federal Reserve Chairman Ben S. Bernanke on the eve of a Group of Seven meeting.

The IMF this week cut Japan’s growth forecasts in a semi- annual report. The world’s second-largest economy will expand 1.7 percent in 2008, slower than the 2 percent forecast in July, because of a “more significant downturn in the global economy,” the Washington-based institution said in the report.

Muto reiterated the policy board’s stance that core consumer prices, which exclude fresh food, will resume rising in the long term after hovering near zero for some time. Core prices fell 0.1 percent in August, a seventh monthly drop.

He said inflation will take hold “because the bank expects the utilization of resources such as production facilities and the labor force to keep increasing.”

The central bank will carefully examine ensuing economic data and financial-market developments when it decides monetary policy, Muto said.

Export growth accelerated, industrial production climbed to a record and wages rose for the first time this year, data for August show, suggesting the economy will rebound from a second-quarter contraction.

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