By Leika Kihara
TOKYO (Reuters) - Premier Shinzo Abe's victory in last month's election may make it difficult for the Bank of Japan to dial back its radical stimulus next year despite the rising cost of prolonged monetary easing, former BOJ board member Sayuri Shirai said on Friday.
Critics, including Shirai, have warned that maintaining ultra-easy policy for too long could hurt, rather than help, the economy by eroding margins on loans and discouraging banks from boosting lending.
In Zurich this week, BOJ Governor Haruhiko Kuroda referred to an academic study warning that lowering interest rates too far could be counter-productive for the economy.
Shirai said the BOJ should start withdrawing stimulus by hiking its yield target and slowing asset purchases next year, given the rising cost and diminishing returns of its policy.
"When the economy is in good shape like now, the BOJ needs to normalize monetary policy so it has the tools available to fight the next recession," Shirai told Reuters.
"But the election result has made that difficult," she said.
Raising the BOJ's 10-year government bond yield target could trigger an unwelcome yen rise by narrowing the interest rate differentials between Japan and the United States, Shirai said.
Any sign the BOJ could withdraw stimulus could also trigger an outflow of funds from overseas investors, who piled into Japanese stocks on expectations the central bank will keep its money spigot wide open, she said.
"The BOJ probably wants to slow its asset purchases," Shirai said. "But that may be difficult because the government puts a high priority on keeping stock prices high and the yen weak."
Abe, who came into office in 2012 vowing to eradicate two decades of economic stagnation with his "Abenomics" stimulus policies, won a landslide victory in the Oct. 22 election.
That has heightened market expectations Abe will reappoint Kuroda, hand-picked by the premier to help eradicate deflation, when his five-year term ends next April.
"There's a pretty high chance Kuroda will be reappointed," Shirai said. "The positive effect of the BOJ's policy is limited, but it would be hard for Kuroda to change it."
Under a new policy framework adopted last year, the BOJ now guides short-term interest rates at minus 0.1 percent and the 10-year bond yield around zero percent via huge asset purchases.