"This bill would support the taking of innocent human life in the hope of finding medical benefits for others. It crosses a moral boundary that our decent society needs to respect. So I vetoed it," Mr Bush said at the White House.
His veto of the Stem Cell Research Enhancement Act came despite its widespread support among the US public and ardent backers in Congress, who urged him to reconsider his stance,
The bill would have lifted rules set by Mr Bush in 2001 making federal funds available only for research on a small number of embryonic stem cell lines which existed at that time.
The stem cell research endorsed by the Senate on Tuesday would have used embryos left over from in vitro fertilization (IVF) procedures to help create cures from some of medicine's most devastating diseases, like Parkinson's and Alzheimer's.
Supporters of the measure pointed out that if not used for science, the vast majority of those embryos would be destroyed anyway.
The president had long vowed to veto the bill because of his deeply held moral beliefs that destroying human life is wrong, even in its earliest form, and even in the interest of research that could lead to potentially life-saving medical breakthroughs.
Federal funds are barred from supporting work on new lines derived from human embryos, a restriction that opponents say hampers overall research.
Mr Bush announced the veto at a White House signing ceremony for alternative bioethics legislation known as "The Fetus Farming Prohibition Act."
The legislation makes it a crime to initiate a pregnancy for the sole purpose of obtaining human organs or tissue for research.
Present for the announcement were several families with so-called "snowflake babies", children born from donated embryos left over from IVF treatments.
The ceremony was a pointed reminder that the clump of cells proposed for research under the vetoed Stem Cell Research Enhancement Act was actually a human life.
In London, Martin Rees, the president of the Royal Society -- Britain's de facto academy of sciences said the US policy "is slowing down the global effort to develop therapies for a range of diseases and illnesses."
"If the present restrictions remain, it would surely mean that the United States will continue to fall behind in this important and exciting area," said Mr Rees.