MONEY MARKETS-Benchmark rates at lows as H1 ends smoothly

* Euro rates mark new low as liquidity remains high

* Banks take 106 bln euros in 1-wk funds

* End of first half of year set to pass smoothly

By Kirsten Donovan

LONDON, June 30 (Reuters) - The interbank cost of borrowing euros for three-months marked a new low on Tuesday as the end of the first half of the year looked set to pass with minimal strain on money markets following last week's huge injection of liquidity.

Benchmark three-month dollar and sterling Libor rates also fell, but overnight rates in all three currencies inched higher as banks demanded cash to balance their books on the last day of the month.

However the increases were only in the region of one or two basis points, compared with over a full percentage point in the overnight dollar rate USDONDFSR= at the same point last year.

With 442 billion euros of 1-year money sloshing around the system after the European Central Bank's historical liquidity providing operation last week, most euro Libor rates ground lower.

Once again, a large amount of that money made its way straight back to the ECB, suggesting banks are cautious about lending the money on, preferring to hoard it at least until books have been balanced at the end of June.

The ECB said 242 billion euros were deposited overnight, a five-month high [ID:nFAT004761], and interbank trading activity remains subdued. However traders expect a pick up later in the week once the second half of the year begins and banks have new counterparty limits available.

"The proximity of half-year end... will likely have limited the full effect of (the ECB's) liquidity injection in lowering rates and stimulating interbank lending activity," ICAP economist Don Smith said.

"There's a good chance the latter half of the week experiences a renewed bout of downward pressure on euribor rates."

Some of the excess liquidity did leave the market on Tuesday however, with banks scaling back participation in the ECB's one-week tender.

Four hundred and five banks took funds totalling almost 106 billion euros. That was the lowest amount allotted since 2002, according to Morgan Stanley, and compared with a maturing amount of near 168 billion euros and a benchmark amount, based on ECB liquidity forecasts, of minus 229.5 billion. [ID:nECB000007]

That liquidity reduction could mean overnight interest rates could struggle to get much lower after EONIA EONIA= fixed at a record low of 0.381 percent on Monday, but equally they were not seen rising significantly yet.

"Today is quarter-end so we may see rates go up a little and thereafter until the end of the reserve period (next Tuesday) rates are likely to remain low, in the range that we're seeing," said Dresdner Kleinwort rate strategist Christoph Rieger.

"Then the big question is what happens in the next reserve period, our preliminary indications are that there will still be way too much cash in the system."

FOCUS TURNS TO ECB MEETING

Attention now turns to the ECB's policy meeting on Thursday where it is expected to keep its main refinancing rate at a record low of 1.0 percent, but may fill in some of the blanks surrounding its asset purchase programme. [ID:nLU618923]

Bank President Jean-Claude Trichet could also comment on last week's 12-month tender, possibly presenting it as proof the ECB is committed to fighting recession, despite keeping interest rates higher than many of its peers in other parts of the world. However, it is likely to take some time before it becomes clear if the liquidity injection is working as the ECB intended and banks are increasing the number of loans they make.

Data on Tuesday showed that growth of loans to the private sector in the euro zone eased in May [ID:nLU67809] [ID:nLU302287] but analysts said while the data may worry the ECB, it was not clear why lending was falling.

"It's still very difficult to tell whether it is restrictions to the supply of credit or the demand. It's not very clear that the resrtictions are on the supply side," said Laurent Bilke, Director Economic Research at Nomura.

"I don't think it's enough to trigger a change in the monetary policy stance of the ECB."

Three-month euro Libor rates EUR3MFSR= fixed 1.1 basis points lower at 1.095 percent on Tuesday, while equivalent dollar rates USD3MFSR= crept down to 0.59500 percent.

For full details of Tuesday's Libor fixing see [ID:nLU697294].