Dollar funding costs eased for the seventh consecutive day on Thursday and the U.S. commercial paper market grew for a second straight week.

For the week ended July 21, the size of the U.S. commercial paper market, a vital source of short-term funding for corporate day-to-day operations, rose by $2.4 billion to $1.100 trillion outstanding from $1.097 trillion the previous week, Federal Reserve data showed on Thursday.

Dollar funding costs eased on Thursday with the three-month interbank rate falling below 0.5 percent for the first time in two months and gains in Euro dollar futures implying further declines in the near term.

We've seen Libor come down over the past week, said Gary Thayer, chief macrostrategist at Wells Fargo Advisors in St. Louis. Some of the concerns about the European banks are starting to ease, and if we get through the stress test (results) tomorrow, it would help in reducing those concerns even more. So we still have one more hurdle.

A dovish interpretation of Fed Chairman Ben Bernanke's remarks before Congress on Wednesday - he testifies again on Thursday - allowed September euro dollar futures EDU0 to retest a record high of 99.550 first set in April, while other contracts including the March contract hit all-time highs.

Euro zone interest rate futures also rose across the 2010 and 2011 curve with the most actively traded December Euribor futures FEIZ0 reaching three-week highs of 98.98.

Bernanke was relatively dovish and the prospect for a very prolonged period of accommodative monetary policy and even some expectations the Fed could resume quantitative easing is behind this price action, said BNP Paribas strategist Patrick Jacq in Paris.

The three-month dollar London interbank offered rate USD3MFSR= was fixed at 0.49781 percent, the lowest since May 21, while the spread over the equivalent Overnight Index Swap -- a gauge of money market stress -- fell two basis points to 30 basis points.

SLOWING

The pace of increase in euro interbank lending rates slowed after banks rolled over more one-week funds earlier in the week, meaning there was a small net addition of liquidity.

The three-month euro Libor rate EUR3MFSR= was set a touch higher at 0.81625 percent from 0.81438 percent -- the smallest rise in a week.

Euro rates have been rising, helped by banks' repayment of 442 billion euros of one-year loans to the ECB on July 1 which took a big chunk of excess liquidity from the market.

The start of a new reserve maintenance period last Wednesday also saw banks front-load their reserve requirements by putting more cash into their current account holdings at the ECB, wiping more liquidity off the table.

The overnight Eonia rate EONIA= has climbed as high as 0.55 percent as a result. It was set at 0.528 percent on Wednesday, well above lows of around 0.3 percent seen in past months.

I expect next week, we'll see a gradual decline in excess reserves ... as current account holdings decline, the liquidity available in the market will gradually increase, this can help Eonia ease moderately, Jacq said.

With the fall in liquidity, banks put much less cash at the ECB's overnight vault, which dropped to around 48 billion euros, the lowest since mid-May and well off highs of over 200 billion euros.

ECB Governing Council member Ewald Nowotny told Reuters on Wednesday in an interview he expected the ECB to continue to provide three-month loans in full allotment until at least year-end.

As far as we know, this is the first time that an ECB member has commented about the liquidity provision beyond Q3, analysts at Societe Generale said.

We cannot exclude that Nowotny was expressing a personal opinion, rather than the dominant opinion of the governing Council, they said, adding they'll look for more signs of an extension of the full-allocation tenders. (Editing by Padraic Cassidy)

Ben Bernanke BNP Paribas