* Dollar interbank rates, spreads edge lower
* Euro strains more evident; ECB reports record o/n deposits
* As tensions ease, more time needed to rekindle lending
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By Jamie McGeever
LONDON, Nov 4 (Reuters) - The bank-to-bank cost of borrowing dollars eased slightly and spreads narrowed early in London on Tuesday, although signs of continued improvement in euro and sterling money markets were less visible.
The rate at which banks lend dollars to each other for three months was indicated in a wide range, similar to recent sessions but the lower end of Tuesday's range was 1.2 percent, almost as low as the Federal Reserve's target for overnight federal funds.
The premium paid for borrowing unsecured dollars on the interbank market over U.S. government borrowing costs or anticipated official policy rates continued to narrow too, evidence of continued easing of money market strains.
But the apparent improvement in dollar money markets wasn't mirrored in European markets quite as much, reflected in the persistently wide level of euro and sterling spreads.
The European Central Bank said on Tuesday banks deposited a record 280 billion euros at the central bank overnight on Monday, suggesting banks would still rather park cash at the ECB for low return than lend to other counterparties.
Market participants reckon London interbank offered rates (Libor) will continue to be fixed lower in the days ahead but perhaps the pace of decline will slow.
"It's a little bit better, fixings have come off quite a bit and that's what we need to see to get to the end of this," said a money markets trader in The Netherlands.
"Libors do look pretty good at the moment and if banks get a bit of trust to lend out -- which they could because of the government guarantees and the printing press is quite a powerful machine -- ... but I wouldn't say we're fully there yet."
In London on Tuesday interbank rates for overnight dollar
deposits
Three-month dollar deposit rates were indicated in a range of 2.2-3.7 percent compared with 2.6-3.7 percent.
The premium paid for three-month dollar Libor over comparable T-bill yields -- known as the "TED" spread -- was indicated around 240 basis points, the narrowest since late September, Reuters charts showed.
EUROPEAN STRESS
The dollar Libor/OIS spread -- the Libor premium over Overnight Index Swap rates and a closely-watched measure of the flow of credit through the financial system and broad market stress -- narrowed to around 220 basis points.
That's the smallest gap since late September too, shortly after U.S. bank Lehman Brothers went to the wall.
"The present spread is still twice as large as it was after Lehman closed its doors, but the improvement brought about by the stepping-up of official intervention is still significant," wrote Laurence Mutkin, head of European rates strategy at Morgan Stanley in a note to clients.
"By contrast, sterling and euro spot LIBOR/OIS spreads have barely budged during the past month. Of course, sterling and euro spreads never widened as far as the dollar spread ... but if the pace of narrowing in the U.S. continues, the sterling and euro markets will start to look like laggards," he said.
The three-month sterling Libor/OIS spread was last indicated around 231 basis points, and the British Bankers' Association will conduct its daily Libor fix between 1100 and 1200 GMT.
On Tuesday the ECB and Bank of England injected a combined $83 billion in 84-day dollar liquidity into the financial system, and the ECB alloted $650 million in a parallel currency swap.
In other developments, the Wall Street Journal reported on Tuesday that the U.S. Treasury is considering using its $700 billion rescue fund to buy stakes in a broader range of financial companies, not just banks and insurers, including bond insurers and specialty finance firms.
And Australia's central bank slashed interest rates by three quarters of a percentage point to 5.25 percent to limit the effect of the financial crisis on the real economy, an aggressive move which some analysts say the ECB and BoE could replicate later this week.
(Reporting by Jamie McGeever; editing by Stephen Nisbet)