Euro lending costs, 7-day ECB borrowing rises

LONDON, June 22 (Reuters) - Benchmark bank-to-bank euro lending costs edged higher on Tuesday as demand for funds increased before the quarter end and the expiry of the European Central Bank's 442 billion euro one-year refinancing operation.

Three-month euro Libor rates EUR3MFSR= climbed by 0.25 basis points to 0.66688 percent, the highest since Dec. 28,while equivalent Euribor rates EURIBOR3MD= hit their highest level in eight months at 0.737 percent.Banks can become more reluctant to lend before the end of a quarter, when accounts are constructed, in order to preserve their balance sheet capital.

We're coming up to quarter end next week so there certainly would be a strong funding requirement in the market - I wouldn't be surprised to see Libor rates drift up a bit more into next week, said Kenneth Broux, economist at Lloyds TSB in London.

European banks also sought to keep a tight grip on funds ahead of July 1 when they must repay 442 billion euros ($593 billion) of one-year loans to the ECB, although a three-month tender at the end of the month was expected to be the more heavily used operation to manage the liquidity withdrawal. Greater demand for funding was also shown by a 25 billion euro increase in demand for ECB seven-day loans and a rise in the number of banks seeking funds.

A total of 114 banks bid at the operation, with 151.5 billion euros allotted compared to the previous week when 101 banks borrowed 126.672 billion euros from the ECB.

UK BUDGET British finance minister George Osborne unveiled an emergency budget which cut growth and borrowing forecasts as well as applying a levy on banks. However the change in forecasts was in line with money market expectations and not seen affecting the pace of interest rate rises, analysts said. The bank levy could cause sterling Libor rates to rise,though the impact was not expected to be large.

It may put a little bit of upward pressure on Libors because it doesn't help the credit quality of the banks if they have to pay a lot more money out the door to the government, said David Keeble, head of European fixed income strategy at Credit Agricole in London.

CHINESE IMPACT LIMITED An improvement in risk appetite seen on Monday, after China vowed to allow its currency greater flexibility, faded as investors grew sceptical about how much Beijing would allow the yuan to rise. [MKTS/GLOB]

The net effect on demand for dollar funding was limited, despite some indications that China's change in stance would cause market players to sell dollars to buy Asian currencies. Benchmark dollar Libor USD3MFSR= fixed marginally higher at 0.53825 percent, but has hovered around its current level since late May.

I don't think it materially changes the outlook for dollar funding, said Broux. We are still in an environment where certain European institutions are still struggling to get funding at the right levels, so I think the market for dollar funds is likely to remain quite elevated. (Editing by Ruth Pitchford)