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MONEY MARKETS-Fear of trouble at banks pressures lending

* Three-month dollar Libor near 4-week highs

* Dollar funding costs rise amid persistent bank worries

* Euro borrowing costs ease on hopes for ECB rate cut (Adds analyst comments, changes dateline)

NEW YORK/LONDON, Feb 3 (Reuters) - Bank lending rates rose on Tuesday to their highest levels since early January as persistent worries about a loss-ravaged financial sector made firms less willing to lend.

Rising for a third straight session, the three-month London interbank offered rates for dollar funds USD3MFSR= edged up almost 1 basis point to 1.233 percent. For details, see [ID:nL35285]

Markets were so strained by a crisis that was stretching well into its second year that it had become difficult to interpret whether the spike in bank rates, particularly the London Interbank Offered Rate or Libor, was due to fundamental concerns or more technical factors.

For one thing, short-term Treasury yields have spiked higher in recent weeks, dragging interbank borrowing costs higher in their wake.

But there was also lingering concern that, with consumer spending at a standstill and the housing market continuing to crater, losses at the nation’s banks would only keep mounting.

Washington’s approach to rescuing the banking sector, with proposals ranging from asset guarantees to capital infusions, has added to the uncertainty. [ID:nN02444352]

“There’s a substantial fear, and that will likely continue,” said Doug Roberts, chief investment strategist at Channel Capital Research in Shewsbury, New Jersey. “But part of it is, there’s been a slight uptick in the short-term Treasury rate, and Libor usually moves on a steady spread of Treasuries.”

Indeed, the premium paid for Libor funds over anticipated central bank rates, or OIS, held steady at 98 basis points, having already widened from around 91 basis points set last month.

Other factors including the refinancing of maturing U.S. commercial paper also kept rates buoyed, analysts said.

Data last week showed that after three months of total dependency on the Federal Reserve’s Commercial Paper Funding Facility (CPFF), the CP market -- the main vehicle of short-term funding for U.S. companies -- was showing some signs of life.

“The people who have been issuing a lot of CP under the CPFF can either go back and roll that CP, but there is a cost attached to that, or they can issue in the market, which is probably cheaper at the moment,” said Fransolet.

“But if everybody tries to issue in the market, that puts a bit of pressure on Libor rates.” Libor is the world’s leading benchmark to which short-term borrowing costs are referenced.

PRICING IN A DOVISH ECB

In contrast, Libor rates for euro funds eased further as markets bet the European Central Bank will continue its rate-cutting campaign following recent economic reports.

Data on Tuesday showed producer prices in the euro zone dropped more than expected in December, giving the ECB more room to cut interest rates as inflationary pressures ease.

However, having just lowered borrowing costs about three weeks ago, the ECB is expected to take a pause at this Thursday’s policy meeting, before resuming cutting rates next month. [ECB/INT]

Meanwhile, commercial banks deposited more cash at the ECB’s overnight vault, again showing their preference to stash cash at the central bank rather than lend to each other.

Figures on Tuesday showed banks deposited nearly 176 billion euros ($228 billion) in total as of Feb. 2, up from about 165 billion euros reported on Monday.

In the next few days, the U.S. Treasury Department will outline new requirements for Wall Street firms receiving federal aid and further steps to rescue the financial system.

U.S. President Barack Obama is trying to get a new stimulus package, now valued at $900 billion, passed by mid-February.

Highlighting the urgency in mending the financial sector, Obama said some banks have likely not fully acknowledged all their expected losses and would have to write those down, and that “some banks won’t make it.” [ID:nN02437430] (Reporting by Pedro Nicolaci da Costa; Editing by Tom Hals)

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