* Benchmark euro, dollar interbank lending rates rise further
* Confusion over implications of short-selling ban weigh
* Swap spreads widen, other risk measures remain elevated
By Kirsten Donovan and Umesh Desai
LONDON/HONG KONG, May 19 (Reuters) - Key euro and dollar interbank lending rates pushed higher on Wednesday, with uncertainty over Germany's short-selling ban weighing on market sentiment.
The German move bans naked short-selling of euro-denominated government bonds and shares in Germany's 10 leading financial institutions, as well as related transactions in credit default swaps, although market participants were still trying to work out the exact implications of the move.
The euro EUR= fell to a fresh four-year low, equity markets tumbled and core German Bunds and U.S. Treasuries rose, which in turn pushed swap spreads wider.
"The reaction has been defensive, which tends to exaggerate the tensions we've seen beforehand, so the result is the opposite of what was probably intended," said Commerzbank rate strategist Christoph Rieger.
The September Libor/OIS three-month spread at almost 39 basis points remained double its level in mid-April, reflecting those tensions.
Two-year U.S. swap spreads -- a key gauge of financial stress -- rose as much as 1.25 basis points to 40.25 basis points USD2YTS=TWEB, having pushed out more than 10 basis points from last week's lows.
Tullett Prebon's head of G-7 economics Lena Komileva, said concerns about risk trapped on bank balance sheets and fears that policy intervention might leave the market long of mispriced credit risk and short of a hedge were destroying confidence at the same time.
"Without confidence market efficiency will continue to decline until liquidity trickles down to the bare minimum," she said.
"The growing disconnect between the ECB's liquidity actions and Euribor rates already sends an alarm signal that policy is no longer playing a corrective role for market systemic risk."
Three-month euro Libor rates < EUR3MFSR=> fixed at four- month highs of 0.635 percent, more than five basis points higher than the all-time lows seen in early April despite excess liquidity in the banking system having risen since then.
Three-month Euribor rates EURIBOR3MD= also hit fresh four-month highs.
SHORT-SELLING BAN MAY PRESSURE SWAP RATES
Pressures in the European banking and government bond markets have left some banks holding paper which is virtually impossible to discount or fund and so they have had to turn to the European Central Bank for funds, albeit at a higher rate.
To help Europe, the U.S. Federal Reserve last week redeployed swap lines that give European firms access to dollars.
But in one sign some funding pressures may be easing, the ECB received no bids for its latest offer of seven-day dollar funds on Wednesday.
Analysts have said the funds are expensive at 1.22 percent compared with rates in money markets.
Three-month dollar Libor < USD3MFSR=> rose more than a basis point to 0.4775 percent, the highest since the end of last July.
Analysts said the ban on naked short sales of euro-denominated government bonds could result in higher funding rates as markets use interest rate swaps in place of short-selling to hedge positions ahead of any future issuances.
"If you need to short government bonds to prepare for a bond issue, the only way to hedge is to pay the interest rate swaps instead of selling bonds," said Sean Keane, managing director at Triple T Consulting. "LIBOR will start pushing up if people are going to pay swaps."