MONEY MARKETS-Dollar Libor falls, U.S. CP market shrinks

* Benchmark dollar Libor falls to lowest since early April

* U.S. commercial paper market smallest in two months

* Euro zone bank lending to companies remains in doldrums (Updates U.S. action, changes dateline, previous London)

By Richard Leong

NEW YORK, Aug 26 (Reuters) - A key bank-to-bank rate on dollars fell on Thursday, as data pointing to a cooling U.S. economy fueled expectations that the Federal Reserve will leave policy rates near zero, possibly into 2012.

The benchmark London interbank offer rate on three-month dollars USD3MFSR= fell to 0.29938 percent. It was the first time it fell below 0.3 percent early April.

Worries over a fizzling economic recovery have also reined in corporate credit appetite, as companies issued far less commercial paper in recent days, investors said.

"A lot of this comes from the fact that companies are not needing the funding," said Sean Simko, fixed-income portfolio manager with investment management company SEI in Oaks, Pennsylvania.

For the week ended Aug. 25, the size of the U.S. commercial paper market, which companies tap to fund inventories and payrolls, fell by $23.7 billion to $1.087 trillion outstanding from the previous week. This was the lowest level in about two months. For more, see [ID:nN26217958]

While supply of short-dated debt like commercial paper has been dwindling, investor appetite for it has not.

Some corporate treasurers have decided to issue less short-term debt in favor of selling more long-term securities in a bid to lock in the historic low borrowing costs.

The ultra low rate climate has been a boon for borrowers but a struggle for investors who have been competing for a shrinking pool of investments that generate decent income.

"Not only do you have to battle low rates, you are also battling supply," Simko said. "It's a challenging environment for investors."

EURO ZONE LENDING STILL STICKY

In the euro zone, growth in loans to euro zone firms and households accelerated in July, the European Central Bank said, but loans to companies remained negative, down 1.3 percent over the year versus a 1.6 percent fall in June. [ID:nLDE67P0GA]

"The data signals very clearly there is no upside inflation risk but at the same time the numbers are not weak enough to signal there is a severe risk of deflation, from the monetary side at least," said Klaus Baader, Societe Generale economist in London.

An increase in loans to non-financial corporations would be needed before the ECB would remove its accommodative stance. "For the ECB meeting next week it is a clear signal that we won't see any change in the accommodative stance in the near future because we first need to see a turn in the credit cycle," said Carsten Brzeski, economist at ING in Brussels.

The ECB has said unlimited liquidity will be on offer in one-week and one-month operations until at least mid-October, and until the end of September for three-month money but the market is expecting the central bank to extend this at least until year-end.

Benchmark three-month euro Libor rate EUR3MFSR= were steady at 0.82875 percent on Thursday. This gauge of banks borrowing euros from each other has risen from a low of 0.57563 percent in early April. See [ID:nEAP000039] for latest Libor fixings from the BBA (Additional reporting by Kirsten Donovan in London; Editing by Dan Grebler)