* Case raised questions about media freedom, threatened ties
* Difficult to conclude intent to defame or libel president -court
* Japan's Prime Mininter Shinzo Abe welcomes verdict (Adds comments from Japan PM, journalist, details)
By Ju-min Park
SEOUL, Dec 17 (Reuters) - A South Korean court on Thursday cleared a Japanese journalist of defaming the South Korean president in a case that raised new questions about media freedom and had threatened to inflame relations between the uneasy neighbours.
Tatsuya Kato, former Seoul bureau chief of Japan's Sankei Shimbun newspaper, was indicted in October last year.
Prosecutors said a report he wrote in August 2014 over President Park Geun-hye's whereabouts during a ferry disaster, which referred to a rumour she was with a man at the time, was based on false information, had no foundation and damaged her honour. The president's office said the rumour had no merit.
"The court views the conduct of the defendant was in the realm of freedom of the press," Judge Lee Dong-geun said at the end of a three-hour hearing, speaking for a three-judge panel.
"It is difficult to conclude that the defendant intended to defame the president or libel her as a public figure."
Prosecutors who had sought an 18-month prison term, declined to say if they would appeal against the decision.
Kato told a news conference prosecutors should accept the verdict and not seek an appeal.
"The process was unfair and discriminatory from the start," said Kato, whose newspaper is known to take a conservative approach to delicate issues of wartime history that still plague bilateral ties.
South Korea's foreign ministry had asked the court to consider Japan's request for leniency, given the two countries' recent efforts to improve ties.
Japanese Prime Minister Shinzo Abe welcomed the verdict.
"I expect that it will have a positive effect on the Japan-South Korean relationship," he said in Tokyo.
Relations between the neighbours are strained over what South Korea sees as Japanese leaders' reluctance to properly atone for the country's colonial wartime past, especially over the issue of Korean "comfort women", as those forced to work in Japanese military brothels during World War Two are known.
The case drew criticism from media and human rights groups over Park's stance on freedom of the press and fuelled worry that the legal system could be used to stifle political opposition.
Kato had remained free during the months-long proceedings. A ban on him travelling overseas was lifted in April.
"It is good news that Kato will not go to jail," said Benjamin Ismail of Paris-based media advocacy group Reporters Without Borders. "However, the need to modify the defamation law remains."
The verdict came amid a politically charged debate over a decision by Park's government to replace privately published history textbooks in schools with a government-issued version. (Additional reporting by James Pearson in SEOUL and Tetsushi Kajimoto in TOKYO; Writing by Jack Kim; Editing by Tony Munroe and Clarence Fernandez)