UPDATE 4-BOJ's Nishimura: Japan economy risks remain high

* Must keep monetary easing for sustained economic recovery

* Biggest risk to Japan remains world economy

* Ending crisis steps different from exiting easy policy

* Should review fund steps in accordance with market recovery (Adds comments from news conference)

KOBE, Japan, Oct 21 - Bank of Japan Deputy Governor Kiyohiko Nishimura warned on Wednesday that risks facing the nation's economy remain high, meaning the central bank must stick to its easy monetary policy for now.

Nishimura said the biggest risk remained the world economic outlook. The bank's main scenario is for the world economy to return to moderate growth, but Nishimura also outlined some of the risks to that scenario.

"If employment conditions keep worsening due to balance sheet adjustments and that weighs on demand, the world economy could slow down.

"If emerging economies grow faster than expected and their demand for resources increase, that could aggravate the terms of trade for developed countries and tip them into a situation like stagflation," he said.

On the central bank's emergency measures to support corporate funding, he repeated its line that it will decide whether to extend them beyond December either at its next policy meeting on Oct. 30 or later.

The BOJ deferred a decision last week on withdrawing support for corporate finance in the face of pressure from some cabinet ministers who worry that a quick exit from emergency steps to support corporate funding would hurt an economy just emerging from its deepest recession in 60 years.

Nishimura said it would take a long time for price changes to return to desirable levels, not only in Japan but in other major economies too, and he reiterated the need to prevent deflation from hurting Japan's economy.

"Our main scenario is for Japan's economy to continue picking up moderately as a trend, but uncertainty over the outlook remains high. The biggest risk lies in developments in overseas economies," Nishimura said in a speech to business leaders in Kobe, western Japan.

TO REVIEW FUND SUPPORT

Central bank officials have been drawing a distinction between the emergency funding-support steps, which some think it may soon scrap, and its easy monetary policy, which is widely expected to remain unchanged until 2011 or later.

"The emergency measures we adopted to deal with excessive anxiety among market players and a sharp deterioration in market functions are a different matter from exiting our macroeconomic policy," Nishimura said.

"They should be reviewed in accordance with the degree to which markets have recovered, and to which nervousness among market players has retreated," he said. "(The BOJ's) CP and corporate bond buying have fulfilled a certain role as excessive anxiety among market players has receded," Nishimura said.

Nishimura is the first board member, aside from Governor Masaaki Shirakawa, to speak since the policy review last week.

But Nishimura dropped few hints on what the bank plans to do, toeing Shirakawa's line that it will look at temporary steps as a whole before making decision.

"Nishimura seems to be suggesting that the BOJ may decide to replace special market operations for supporting corporate finance with regular market operations as early as at the coming policy meeting on Oct. 30," said Yuichi Kodama, an economist at Meiji Yasuda Life Insurance.

"But it remains to be seen whether the bank will be able to do so without causing unwelcome friction with the government."

Nishimura has mostly toed the BOJ line on policy and voted for its interest rate cuts and corporate fund support measures to ease credit strains in the wake of the financial crisis a year ago.

"Commercial paper and corporate bond purchases were introduced when money and credit markets were dysfunctional. With those markets now behaving more normally, it would make sense for these programmes to be wound down," said Shane Oliver, chief economist and head of investment strategy at AMP Capital Investors in Sydney.

"The BOJ won't be raising rates for the next 18 months at least ... There have been some signs of recovery but deflationary pressures remain pretty intense and domestic demand remains weak."

The BOJ will issue its twice-yearly outlook report on Oct. 30, which forms the basis for its monetary policy decisions, and is expected to forecast three years of deflation to March 2012.