MONEY MARKETS-Dollar Libor near 1 pct, repo penalty begins

* Three-month dollar Libor inches near record 1 pct low

* U.S. repo penalty produces no market impact

* T-bill rates rise on less grim economic data

* European markets shut for May Day holiday (Updates market action, changes dateline, previous London)

By Richard Leong and George Matlock

NEW YORK/LONDON, May 1 (Reuters) - Most interest rates banks charge each other fell on Friday, as three-month dollar funding costs inched closer towards their record low of 1 percent amid a gradual improvement in credit conditions.

Investors also reduced their safe-haven holdings of U.S. Treasury bills after less gloomy data on manufacturing and consumer sentiment. The three-month T-bill rate US1MT=RR rose for a second day to 0.15 percent.

"The tone of the market is pretty constructive. We are seeing pretty good demand from money market investors looking to pick up yield," said Alex Roever, short-term fixed income strategist at J.P. Morgan Securities in New York.

Outside of the interbank and T-bill sectors, the U.S. repurchase or repo market traded quietly, as traders will start paying a penalty for not delivering promised securities.

European markets and institutions were closed for the May Day holiday and market participants blamed the lack of liquidity for the tick higher in the three-month euro Libor rate. The holiday also meant no euro overnight rate was fixed.

On Monday, British markets will be shut for a public holiday. A spokesperson for the British Bankers' Association confirmed that only the euro Libor fixing will be made after 1000 GMT on Monday.

The three-month euro Libor rate was fixed at 1.36188 percent, up from 1.36063 percent on Thursday EUR3MFSR=, rising for the first time since early October.

As for its dollar counterpart, the BBA lowered its three-month dollar Libor fixing USD3MFSR= to 1.00688 percent, extending its decline since mid-March.

The spread of three-month Libor over the Overnight Indexed Swap (OIS) rates, or the market's anticipated policy rates, for dollars and sterling narrowed, while the euro spread was steady. [ID:nL196980]

REPO PENALTY BEGINS

The Treasury Market Practices Group, a bond industry consortium, introduced a penalty charge when a repo trade fails on Friday after a long bout of failed trades that got the attention of regulators.