Interbank euro funding costs rose on Thursday as markets adjusted to reduced liquidity, while euribor futures fell after the European Central Bank announced no extension to its programme of unlimited liquidity operations.

The European Central Bank said euro zone interest rates would be held at 1.0 percent while the Bank of England kept interest rates on hold at a record low 0.5 percent.

Benchmark bank-to-bank, euro-denominated lending rates rose, with last week's drain of over 200 billion euros of ECB liquidity putting upward pressure on money market rates.

If you have more banks looking to find liquidity in the market, then probably the balance between demand and supply isslightly elevated, said Patrick Jacq, strategist at BNP Paribas in Paris.

The London interbank offered rate (Libor) for three-month euros was fixed on Thursday at 0.75250 percent EUR3MFSR=,rising by more than 1 basis point from Wednesday's fixing to a level last seen in early September 2009.

After the relatively smooth expiry of a 442 billion euro 12-month ECB tender last week, analysts said the likelihood of the ECB announcing an extension to unlimited liquidity was low.

However, euribor futures fell when no further measures were introduced at the ECB's news conference, implying a rise in euribor rates in the future.

Probably there were some expectations that (ECB President Jean-Claude Trichet) could announce an extension of full-allotment, fixed-rate operations and he did not, so maybe some have to reassess the market, Jacq said.

The ECB has previously said it will continue to provide banks with unlimited one-week funding until at least October, and full allotment three-month tenders until September.

INTERBANK APPREHENSION The rise in interbank rates following the withdrawal of liquidity was a sign of apprehension in wholesale markets and not necessarily positive, said Padhraic Garvey, strategist at ING in Amsterdam.

The ECB's refi rate at 1 percent is a penal rate on any collateral, and every time wholesale rates rise it makes this rate less penal relative to better collateralised alternatives, which in turn creates a distortion in the market, he said.

The results of the banking stress tests, due on July 23, could influence the central bank's exit strategy from unlimited liquidity if they revealed a large number of banks were struggling to access funds in the money markets, analysts said.

Stress tests will be carried out on 91 European banks to gauge resilience, with markets keenly seeking further details on how rigorous the tests will be.

If the market takes the view that what they're going to test for is going to be more conclusive in providing evidence,then that may be seen as a reason for rates to come down, said David Owen, chief European financial economist at Jefferies.

BNP Paribas