MONEY MARKETS-Interbank lending costs ease, T-bill rates rise

* Dollar Libor eases, spread vs OIS steady

* U.S. Treasury bill yields edge up

* Euro, sterling Libor/OIS spreads narrowest in 3 months

(Adds U.S. developments, more comments, byline)

By Ian Chua and John Parry

LONDON/NEW YORK, Jan 6 (Reuters) - The cost of bank-to-bank lending eased on Tuesday and yields on ultra short-dated government debt edged up, hinting that risk aversion is slowly retreating from the historical extremes reached in 2008.

The collapse of major entities such as Lehman Brothers last year dealt a severe blow to confidence among banks, heightening distrust and causing lending between financial institutions to grind to a halt.

Since then, central banks around the world have funnelled cash to banks and introduced measures like guaranteeing their debt, helping to calm the interbank money market.

The big question this year is whether banks will start lending to each other again without central bank assistance, analysts say.

The behaviour of London interbank offered rates (Libor) over the coming days and weeks will be a crucial signal of whether or not liquidity is returning to money markets, said London-based Laurence Mutkin, analyst at Morgan Stanley.

"If not, authorities around the world will find they still have a lot of wood to chop -- and, monetary policy being a tool that requires money-market liquidity to be effective -- they will need unconventional tools with which to do the chopping, so to speak."

In the latest of a string of unconventional policy measures to support financial markets and the U.S. economy, the Federal Reserve on Monday began buying U.S. agency mortgage bonds, kicking off its purchase programme of as much as $500 billion aimed at helping to turn around a slumping housing sector.

SENTIMENT IMPROVING

Investor sentiment generally appeared to be improving in the new year with prospects of new fiscal stimulus plans by U.S. President-elect Democrat Barack Obama and in Germany helping boost appetite for riskier assets such as stocks.

U.S. Treasury bill rates rose as investors continued to venture tentatively out of the haven of ultra short dated government securities into riskier assets such as stocks and corporate bonds.

A $24 billion auction of 4-week U.S. Treasury bills was sold at a high rate of 6 basis points on Tuesday, up from 3 basis points at a sale last week and up from zero earlier in December when panicked investors rushed to the comparative safety of short-dated government paper.

Market analysts noted Tuesday's move but viewed this as a still tentative hint that risk aversion might ebb in a sustained way.

"Wake me up when we get to 25 basis points," said John Ryding, chief economist at RDQ Economics. "You won't get bill rates much above 15 or 20 basis points in this kind of environment," he added.

The so-called "TED spread" TEDCASH -- the premium investors pay for three-month interbank lending over comparable Treasury bill yields and a closely watched measure of financial market stress -- narrowed to around 126 basis points.

Reuters data show that's the narrowest since Sept. 12, 2008, just before official news about the collapse of Lehman Brothers.

"The progress we have had to date on the TED spread is very encouraging but if you look back historically I don't know if you will get to pre-crisis levels anytime soon," Ryding said.

Before the global credit crisis first erupted in summer 2007, the TED spread was about 30 basis points, he said. In the current environment, a move down to 100 basis points "would be a really significant improvement," Ryding said.

The spread of three-month dollar Libor over anticipated central bank rates -- a gauge of interbank money market stress -- has also narrowed in the last few weeks but not to pre-Lehman levels.

That spread was last at 124 basis points, well off the peak above 360 basis points set in October, but still above levels around 86 basis points seen on Sept. 12.

Three-month dollar Libor, which unexpectedly rose on Monday, resumed its fall, edging down to 1.411 percent from 1.421 percent. For more on Tuesday's Libor fixings from the British Bankers' Association and Libor/OIS spread movements, see [ID:L6472592].

In Asia, interbank dollar lending rates dropped to fresh four-year lows with the three-month rate in Singapore SIUSDD=ABSG falling to 1.40786 percent from 1.4183 percent on Monday, hitting their lowest levels since mid-2004. (Additional reporting by Vidya Ranganathan in SINGAPORE; Editing by Chizu Nomiyama)