Traders pare U.S. rate-hike view on weak GDP data

NEW YORK (Reuters) - U.S. interest rate futures rose on Friday as data on weaker-than-forecast economic growth in the second quarter led traders to roll back expectations of a U.S. rate increase from the Federal Reserve.

A key measure on what banks charge each other to borrow dollars for three months posted its smallest daily rise in more than a week, prompted by U.S. money market funds' reduced demand for short-term bank debt.

Gross domestic product, the government's broadest economic gauge, grew at a 1.2 percent annual rate after rising by a downwardly revised 0.8 percent pace in the first quarter, the Commerce Department said on Friday.

"Today's GDP data would suggest there are still more mountains to climb before tightening policy," said Todd Colvin, senior vice president at Ambrosino Brothers in Chicago.

Federal funds futures reached their highest levels in more than a week following the disappointing GDP data.

The fed funds contract for December delivery implied traders saw a 33 percent chance the U.S. central bank would raise its target range on policy rates, currently at 0.25 percent to 0.50 percent, by year-end, down from 43 percent on Thursday, according to the CME Group's FedWatch program.

Earlier this week, rates futures suggested traders had priced a 53 percent probability the Fed may raise rates by December.

Meanwhile, the London interbank offered rate on three-month dollars for an 11th straight session to 0.7591 percent, its highest since May 2009. It was up 0.26 basis point, which was its smallest increase since July 19.

The drop in money fund demand for bank debt stemmed from some prime funds converting to ones that own U.S. government-only securities in advance of an Oct. 14 deadline on new regulations.

"The three-month Libor's rise has muddied the waters, as money market reforms have forced the shift from prime funds to government-Treasury funds," Colvin said.

(Reporting by Richard Leong; Editing by Jonathan Oatis)