MONEY MARKETS-Dlr, stg Libor hit record lows as c.banks meet

* Benchmark 3-month dlr, stg Libor rates hit new record low

* 3-month euro Libor edges up for second straight day

* Lending activity still subdued as banks deleverage

(Updates with Libor fixings, changes byline, dateline previous SINGAPORE)

By Emelia Sithole-Matarise

LONDON, Aug 18 (Reuters) - The interbank cost of borrowing dollar and sterling rates set record lows on Tuesday while euro rates edged up ahead of a central bankers' meeting expected to provide hints on how they will exit liquidity measures made during the global credit crisis.

Central bankers at an annual meeting convened by the Federal Reserve in Jackson Hole, Wyoming from Wednesday are expected to discuss how to gradually turn off liquidity taps that have helped money markets stabilise two years into the crisis. The extra cash has driven short-term borrowing costs to their lowest levels ever and brought some key gauges of stress in short-term lending markets to levels pre-dating the turmoil.

London interbank offered rates for three month dollars fixed at a lifetime low of 0.42500 USD3MFSR= as did the equivalent sterling rate at 0.75125 PCT GBP3MFSR=.

The three-month euro Libor rate, however, edged up for a second day running to 0.83438 percent EUR3MFSR= from 0.83313 percent on Monday.

For the latest Libor fixings see [ID:nLI148626]

The three-month premium paid over anticipated central bank rates expressed by the London interbank offered rate over Overnight Index Swap rates for dollars has narrowed to 25 basis points -- a level former Federal Reserve Chairman Alan Greenspan recently said would indicate normal money market conditions.

Bank of Spain data showed bad loans held by Spanish banks dropped in June for the first time since December 2006 [ID:nLI76497], providing a further ray of light for the financial sector.

Some market analysts, however, said while confidence has returned to money markets after the raft of liquidity measures, interbank activity remained subdued.

"A lot of aspects of the market are back to normal. But one thing is to look at levels and another is to look at the activity around the number and we see activity is still fairly subdued," said Gianluca Salford, a strategist at JP Morgan in London.

"Banks are still in a deleveraging process and it's not clear lending by the banks is the best use of their money at this point in time," he said.

LIQUIDITY BUFFER

Commercial banks were still holding onto much of the ECB's almost half a trillion euro injection of one-year funds made at the end of June, with overnight deposits at the central bank edging higher above 100 billion euros on Monday. [ID:nFAT006768]

In its August bulletin, the ECB said even though the liquidity buffer ws being held in its overnight deposit facility, it did not decrease its confidence-enhancing impact.

"But banks' balance sheets need to be monitored to get indications of how added liquidity was being used," it said in the bulletin released on Tuesday.

See [ID:nLD277553]

Money market participants are also keen for clues on how the ECB will decide to handle its next tender of one-year funds next month after the region's two largest economies surprisingly emerged from recession in the second quarter.

The ECB has pledged to provide banks with as much money as they want for now and so must weigh whether to charge banks more than the 1 percent it has been charging in its recent money market operations.