* Lower lending rate lifts demand for dollar auction * 3 regional banks main bidders -market source * 1-week auction no good indicator of market strains * Market keen on 3-month dollar auction Dec. 13 By Rie Ishiguro TOKYO, Dec 6 (Reuters) - The Bank of Japan on Tuesday supplied dollars in market operations for the first time since last week's coordinated action by the world's top central banks aimed at giving banks easier access to the greenback as Europe's debt crisis intensified. The Japanese central bank supplied $25 million in an operation maturing in a week, which was five times the $5 million that the BOJ offered in four, one-week operations last month, but by no means large enough to signal funding strains. "There was stronger demand because of the lower lending rate. But the amount of bids itself is not significant and suggests Japanese banks experimented with the scheme just in case necessity arises," said Tomohiko Katsu, deputy general manager of the asset liability division of Shinsei Bank. Three regional Japanese banks were chief bidders, securing $23 million, an interbank market source said. The lending rate was at 0.6 percent, down from 1.08 percent in a previous one-week dollar auction on Nov. 29, but still above the one-week dollar LIBOR rate of 0.2 percent on Monday. "This is like taking a 10-yen coin out of your purse," a Japanese bank trader said about the small amount, which paled in comparison to tens of billions of dollars that the BOJ supplied in operations after the collapse of Lehman Brothers in 2008. As Tuesday's operation also did not cover the crucial year-end period when funding usually becomes tight, markets are keenly awaiting the upcoming three-month dollar auction to gauge real demand. The Federal Reserve, European Central Bank and the central banks of Japan, Canada, Britain and Switzerland said last week they would reduce the cost of existing dollar swap lines by 50 basis points and extend the size and timing of the lines, to ease strains in financial markets. The dollar-funding scheme, under which the BOJ offers unlimited amounts against collateral, had been untapped for more than a year until last month because it typically used to cost more than borrowing dollars in the open market. NOT TOO WORRIED The increased demand signals funding strains are slowly starting to affect Japan but the BOJ is not too worried and feels that it is a good sign that central banks' coordinated action helped eased the "stigma" financial institutions feel about tapping central bank auctions. The central bank also feels Japanese money markets and bank dollar funding are under far less strain than those of Europe and the United States. Still, it is on guard against any signs of market stress. "Markets are becoming very nervous. What the central bank can do under these circumstances is not just offer liquidity but ensure the money is circulating smoothly," said Atsushi Mizuno, a former BOJ board member and currently vice chairman of Credit Suisse's fixed-income Asia-Pacific business. "That's the big challenge, perhaps more so than whether or not the ECB buys government bonds," he said as he briefed on Europe's debt crisis. Mizuno left the central bank's board in December 2009. Market analysts point out that the auction for three-month dollars on Dec. 13 is likely to draw much stronger bids from both Japanese and non-Japanese banks for securing year-end funding. "As market rates for longer-term funds remain elevated, there could be significant demand for the three-month dollar supply operation. Banks may also take advantage of lower costs even if they have enough money on hand," Katsu said. Last month, the BOJ had supplied $200 million in two operations maturing in three months. The BOJ first offered dollar funds in September 2008 as it joined other central banks in opening the dollar liquidity swap lines with the Fed after the Lehman Brothers meltdown. As the use of the swaps tailed off in 2009, the BOJ ended the operations along with swap lines in February 2010. But the world's central banks re-established temporary dollar liquidity swap facilities in May 2010 in response to heightening strains in European financial markets stemming from a Greek debt crisis. The BOJ added one-week operations following the March earthquake.

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