MONEY MARKETS-Dollar funding costs rise as European crisis rages

* Dollar funding costs edge up, front Eurodollars down

* Traders keep close eye on EURIBOR-OIS, European shares

* Upbeat US payrolls report may help relieve some econ gloom

* Asian cross-currency basis spreads show no major strains

* Treasuries gain as equities beaten lower, T-bills near zero

By Eric Burroughs

HONG KONG, Aug 5 (Reuters) - Dollar funding costs edged up in Asia on Friday as banks hunkered down during one of the worst stock market sell-offs since the financial crisis, with investors dumping risky assets on fears the raging euro zone crisis will compound a global economic slowdown.

Front month Eurodollar futures dipped on expectations that three-month LIBOR would be set higher later in the day, but traders said the dollar markets were holding up thanks to ample liquidity from banks' huge excess reserves held at the Federal Reserve.

"I wouldn't say there is a rush for dollars," said the head of money market trading at a European bank in Singapore. "The traditional hedges against a blow-up haven't paid out."

Asian markets saw some slight deterioration in cross-currency basis spreads as the premium for obtaining dollar funding rose, but the moves were minor compared to the shocks seen during the worst days of the 2007-08 financial crisis.

Australia's central bank said in a quarterly statement that the sovereign debt problems in the United States and Europe could be disruptive enough to a sharp rise in global risk aversion, prompting it to refrain from raising rates until the uncertainty died down.

Still, the Reserve Bank of Australia also said that credit markets have been relatively unaffected by the global turmoil and reiterated its upbeat outlook for the resources sector.

European money markets have been at the heart of the deterioration this week as a plunge in financial shares, especially in Italy, has caused more investors to cut their exposures to troubled euro zone countries across the board.

The vicious circle of widening bond yield spreads slamming equities and financial shares has hit the EURIBOR-OIS spread this week, sending it soaring 22 basis points this week to 57.7 bps.

The European Central Bank's move to resume bond purchases and introduce a longer-term funding operation for banks did little to calm nerves, especially after the ECB failed to purchase Italian or Spanish bonds.

Friday looked to be another ugly one in Europe, with futures on the Dow Jones Euro Stoxx 50 STXEc1 down 2.6 percent and set for a nearly 13 percent slide on the week. Asian shares outside Japan were down 9 percent on the week.

Treasuries extended their sharp gains this week on the relentless sell-off in stocks as investors have rushed to price in a potential recession.

The benchmark 10-year note jumped 17/32 in price to yield 2.348 percent, down 6 bps on the day and 45 bps on the week in a massive bull flattening of the curve as portfolio managers have abandoned plays betting on future growth and inflation.

Making matters worse, news that BNY Mellon -- the world's largest custodian bank -- was charging clients a fee for large deposits because of a huge increase in demand sparked a scramble for cash that pushed T-bill yields to near zero.

PAYROLLS TO RESCUE?

Traders and analysts said an upbeat U.S. employment report would be one outcome that could help settle the jitters about the global economy and ease some of the strains across markets as investors have scrambled to cut risk in their portfolios.

"We are entering the territory where the market strains could become endogenous to the growth process, weighing further on growth," said fixed-income strategists at Deutsche Bank in a note to clients.

"However, we are of the view that sentiment could be boosted quite quickly should the U.S. employment report surprise on the high side."

September Eurodollar futures were down 3 basis points on the day, pointing to a further rise in three-month LIBOR at the fix later in the day.

Three-month dollar funds in Singapore were fixed at 0.26717 percent, the highest since May and up 1.3 bps on the week. On Thursday LIBOR was set at 0.26939 percent , still only slightly higher for the week.

The LIBOR-OIS spread was at 20.3 bps, holding at the highest level in a year and up 6 bps on the week -- still a much milder rise than in EURIBOR-OIS.

In Asia, cross-currency basis swaps widened slightly. The one-year Australian dollar-U.S. dollar basis was quoted at a 4.5 bp premium for dollar LIBOR, the highest since mid 2010 and up from 2 bps last week.

Short-term Aussie swap rates plunged further as market players have rushed to price in rate cuts instead of the rate hikes expected at the start of the week, with the one-year IRS down 70 bps in just four days to 29 bps below the central bank policy rate. (Editing by Ramya Venugopal)