(Updates market action)
By Richard Leong
NEW YORK, July 25 (Reuters) - U.S. interest rate futures climbed on Wednesday, as traders increased their bullish bets that the Federal Reserve is prepared to provide more stimulus to counter a slowdown in the U.S. economy, exacerbated by Europe's debt crisis.
Deferred Eurodollar futures rose for a fourth straight session, touching fresh contract highs.
The recent slew of discouraging news on the U.S. economy, together with worrisome developments in the fiscal situation in Spain and Greece, fed expectations the U.S. central bank could soon act with more unconventional policy tools to lower interest rates in a bid to stimulate borrowing and business activities.
Fed's remaining policy tools include a third round of quantitative easing in the form of large-scale bond purchases -- known as QE3 -- and lowering the interests it pays banks on excess reserves (IOER) they leave with the central bank.
"The market is looking for the Fed to ease at some point with a cut in the IOER and/or a full-blown QE," said Mike Lin, director of U.S. funding at TD Securities in New York. "That's supporting the move of Eurodollar futures higher."
The December 2014 Eurodollar contract last traded up 1.0 basis point at 99.390 after rising to a contract high at 99.395. Eurodollar futures for 2016 to 2019 edged lower after setting contract highs earlier.
Interest rates in the dollar funding market had fallen since last week in anticipation the Fed would lower the IOER from the current 0.25 percent.
Traders bet the Fed would follow the European Central Bank which almost two weeks ago dropped its rate similar to the IOER to zero in an effort to bolster the region's sagging economy.
However, many analysts said the money markets in Europe and the United States are different. They said cutting the IOER would hurt the $2.5 trillion money market fund industry and risk disrupting interbank dollar lending.
Still sentiment on a IOER cut was reinforced by news reports on possibly more Fed action.
"All the stories are indicating a potential chance about an IOER cut next week," TD's Lin said.
Fed policy-makers are scheduled to meet for two days starting next Tuesday.
While the futures market signaled expectations of lower U.S. interest rates, overnight borrowing costs for dollars were steady to slightly higher on the day.
The interest rate on overnight repurchase agreements, a key funding source for Wall Street, traded mostly at 0.22 percent, compared with 0.208 percent -- Tuesday's level on the DTCC GCF repo index level -- which is the benchmark for repo futures launched more than a week ago.
Analysts said the overnight repo rate rose partly on Fannie Mae and Freddie Mac either reinvesting or disbursing to bondholders the monthly cash the two mortgage finance agencies collect from the home loans and securities in their portfolios.
Benchmark three-month dollar Libor held at 0.44810 percent, its lowest level since early November.
The gap between the London interbank offered rate and the overnight indexed swap rate for three-month dollars shrank 1 basis point to 30 basis points.
In the derivatives market, the spread between the two-year U.S. interest swap rate and two-year Treasuries narrowed 0.5 basis point to 22.25 basis points, suggesting traders see chances of more Fed stimulus would help the banking system. (Editing by James Dalgleish)