Hoy, 36, beat Kenny to win gold in the discipline in Beijing four years ago, but rules brought in by the UCI, world cycling’s governing body, means there can be only one representative of each nation in the sprint.
Kenny’s selection leaves Hoy to focus on defending his team sprint and keirin titles.
Despite his disappointment, Hoy magnanimously said that a selection team headed by performance director Dave Brailsford had made the correct decision.
He said: “They made the right call. It is not about individual ambition – it’s about the team getting the most number of gold medals. Therefore you could say you are spreading yourself a bit thin by having one guy taking part in three events, but that is not why they have made the decision. They have picked the best sprinter.”
Hoy and Kenny have been evenly matched since their 2008 battle for Olympic gold.
Kenny outperformed Hoy in the sprint at the two most recent World Championships, which may ultimately have given him the edge, although Hoy had emerged on top at the Olympic test event.
But Hoy believes that his non-selection for the individual sprint may improve his chances of success in the keirin and team sprint thanks to the extra rest he will get between the two disciplines.
“It means I have got the chance to have a proper recovery between the team sprint and the keirin which is a bit of a luxury really,” he said.
“It means I can give it everything in the team sprint and then get that out the way and prepare for the keirin.”
While Hoy and his team-mates focus on track matters, their former colleague Bradley Wiggins – a double gold medallist in Beijing – looks set to make history by becoming the first Briton to win the Tour de France.
Wiggins holds a lead of two minutes and five seconds over Team Sky team-mate Chris Froome with just three stages of the race, which finishes in Paris on Sunday, to go.
Hoy feels Wiggins’ performance can act as an inspiration for Team GB.
“I may be a bit biased because he is an old team-mate and he is a great guy and what he has done is amazing,” Hoy said. “But if he gets to that finish line it will be as good as anything any British athlete has ever done.”