(Updates with more market background)
By Hideyuki Sano and Yoko Nishikawa
TOKYO, Jan 18 (Reuters) - The Bank of Japan kept its key policy rate unchanged on Thursday, raising questions as to whether it succumbed to government pressure to hold off on a tightening.
The BOJ said its board voted 6-3 in favour of keeping rates at 0.25 percent -- the lowest in the developed world -- and the market was now eyeing the possibility of a rate rise as early as next month.
Japanese media, in the run-up to the meeting, had reported the BOJ was unlikely to raise rates and many suspected the government of trying to sway the central bank so that it would not potentially damage the economy with a hasty move.
Prior to those reports, investors had been braced for a rise.
"I think what is worst for the BOJ is that it could look as if they bowed to political pressure," said Yasunori Sone, political science professor at Keio University.
"I think they made the decision because they lacked certainty about the economic recovery," Sone said. "It could appear as if there had been a secret deal between the government and the BOJ."
The decision was far closer than the 9-0 vote at the last meeting when rates were also held steady.
The BOJ has been in a quandary. The economy has been showing an extended recovery but worries remain given soft price pressures and moderate growth in consumption.
"Between now and the February meeting, we will have GDP data and the central bank will be able to confirm the strength of consumer spending," said Mamoru Yamazaki, chief economist at RBS Securities.
Yamazaki said the consumption trend was the main factor behind the decision to postpone a rise.
In the meantime, the market will look to BOJ Governor Toshihiko Fukui for clues about both the policy outlook and the political question. Fukui is slated to speak at 0630 GMT.
The yen fluctuated after the news but by 0530 GMT it was broadly unchanged from before the decision. It was at 120.78 per dollar.
MARKETS WANT CLARITY
The low level of Japanese interest rates has led to protracted weakness in the yen. Even as the dollar has been losing ground against other major currencies, it has risen more than 5 percent against the yen in the past five weeks.
Confusion over the political dimension to BOJ policy, combined with mixed signals on the economy, is making matters difficult for markets.
Mari Iwashita, senior strategist at Daiwa Securities SMBC, said the degree of opposition to steady rates would suggest to some in the market that a rise was on the way.
"But to keep such expectations alive, Fukui will have to send a clear message at his press conference," Iwashita said.
The BOJ increased its call rate last year for the first time in six years, not long after it ended its ultra-easy policy of flooding the market with excess funds.
As Japan emerged from seven years of debilitating deflation, Fukui said the BOJ would be careful and would get rates back to normal levels gradually.
But many economists, including those at the BOJ, now think the year-on-year rise in Japan's core consumer prices will be limited in the near future.
Some think the inflation rate could briefly slip back to around zero or even below if oil prices continue to fall.
Data last month showed Japanese core consumer prices were 0.2 percent higher in November from a year earlier. That compared with a 0.1 percent annual increase in the October data
Household consumption has also been tepid as wage growth has been soft even though companies are increasingly keen to hire more workers.
Slow improvements in consumption and wages have perplexed the BOJ, which has said that strength in the corporate sector should spill over to households.
Japan's economy is going through its longest expansion in the postwar period.
But Hidenao Nakagawa, a ruling party heavyweight and a close ally of Prime Minister Shinzo Abe, has said in recent weeks that a premature rate increase would not only damage the economy but also run counter to the government's policy to boost growth.
The central bank is due to issue its monthly report at 0600 GMT, which will include a mid-term review of its twice-yearly economic outlook.
In that review, the BOJ is expected to say the economy will keep expanding in the fiscal year starting in April, even though the economy is undershooting the BOJ's forecasts in the near term
