MONEY MARKETS-Dollar funding offer caps tension; demand seen limited

* Concerted c. bank action seen capping dollar funding tension

* Dollar lending may be revived but underlying issues unsolved

* Demand expected to be low, swap expensive relative to market

By William James

LONDON, Sept 16 (Reuters) - Coordinated action to provide longer-term dollar funding should stall the rising pressure on euro zone banks and may prompt a small improvement in interbank lending conditions, analysts said on Friday.

Major central banks around the world said on Thursday they would cooperate to offer banks access to three-month dollar loans -- removing a key source of money markets stress built over recent weeks.

Nevertheless, the move was not seen solving the banking sector's core problems -- chiefly their ability to absorb losses stemming from the euro zone sovereign debt crisis.

The European Central Bank currently offers seven-day dollar liquidity each week and the first three-month operation for euro zone banks will take place in October.

By materially reducing the risk of a funding squeeze leading to bank failures, the move to extend liquidity support could encourage some to resume dollar interbank lending.

"When things like this get put in place it often takes away some of the requirement for them because people are more likely to lend (money) themselves," said Gary Jenkins, head of fixed income at Evolution Securities.

"They think 'Why let the central bank make the money? If they're there as a backstop and there is liquidity, I feel more comfortable lending it myself'."

The cost of raising three-month dollars through the cross currency basis swap market eased after the announcement and last stood at -87 bps, having reached the most expensive level in a year at -125 bps earlier this week.

"Although central bank activity denotes great support and provides market relief, it is not the path to a genuine solution. That instead is in the fiscal and therefore ultimately in the political arena," Royal Bank of Scotland strategists said in a note.

CONSIDERING THE COST OF BORROWING

RBS strategist Simon Peck said the high cost associated with tapping the line relative to current market levels would probably keep demand limited to millions, rather than billions of dollars.

Based on current market rates the tender -- expected to be priced at overnight rates plus a 100 basis point premium -- would look expensive until three-month cross currency basis swaps were at least back above -100 bps, Peck said.

Banks borrowed $575 million via the ECB seven-day dollar swap line this week, the second time in a month the facility has been tapped after previously lying unused since February.

Banks' reluctance to use the line may be due to the negative consequences of being seen to borrow from the ECB, which implies that counterparties are either unwilling to lend, or charge a high rate for doing so.

"In an ideal world, these banks would prefer not to use (swap lines) because it does send a critical message. At this extremely sensitive time it is very difficult to actually keep that information private, so that can really stigmatise you," said Michael Derks, chief strategist at FxPro in London.

However, this may play less of a role in demand for the new long-term swap with year-end approaching and money market traders saying that access to three-month funding has been almost non existent except for the very strongest credits.

"There is slightly less stigma to taking (the three-month) up because it's a really good offer -- you'd be mad not to take it if you're finding that your funding duration has collapsed," Derks said. (Editing by Nigel Stephenson)