) --In a sign that European banks are growing increasingly nervous about lending to each other, the three-month dollar Libor rate rose to 0.5181% Thursday according to the British Bankers Association.

The London Interbank Offered Rate represents the cost of borrowing US dollars in the London interbank market. The rate is set by 19 banks based on what they say is their cost of borrowing. The three-month euro Libor rate was at 1.4163%.

European banks' unwillingness to lend to each other is also evident in the widening Libor OIS (Overnight Index Swap) spread. This represents the difference between the rate at which banks are willing to lend to each other over and the market's expectation of the overnight fund's rate. The spread reflects what banks believe is the risk of default in lending to other banks.

The spread is at a two-year high of about 41 basis points, though still well below the financial crisis high of around 350 basis points hit in October 2008, following the collapse of Lehman Brothers.

Meanwhile the bond market is increasingly bearish on the ability of the Euro zone leaders to contain the crisis. German bonds, the supposed safe haven in the region, performed poorly at an auction on Wednesday. The yield on two-year Italian debt on Thursday touched 7.639%, while the 10-year yield was at 7.25%.

But equity markets are still optimistic that a solution can be reached. On Friday, European stocks rebounded strongly, prompting a recovery in U.S. stocks as well.

Bank stocks in the U.S. were making smart gains, with

Bank of America

(BAC) - Get Report

gaining 2.8%,

JPMorgan Chase

(JPM) - Get Report

adding 2.2%, Citigroup rising 3% and

Wells Fargo

(WFC) - Get Report

climbing 1.7% respectively during morning trades.

--Written by Shanthi Bharatwaj in New York

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