CORRECTED-TREASURIES-Yields slip after PPI, long bond in tight range pre-auction

By Alden Bentley

NEW YORK, Sept 10 (Reuters) - Key Treasury yields eased back after news of a surprising drop in August producer prices strengthened the argument for an interest rate cut next week, but the T-bond yield wavered as investors prepared for Thursday's widely anticipated auction.

The Labor Department said on Wednesday that its Producer Price Index for final demand dipped 0.1% after a downwardly revised 0.7% jump in July, thanks to a drop in the costs of services. Economists polled by Reuters had forecast the PPI would advance 0.3% after a previously reported 0.9% July surge.

"It's not that a rate cut was in doubt after Powell, but the data just do suggest that the Fed can cut rates, and now it's a question of size," said Kim Rupert, managing director of fixed income at Action Economics in San Francisco, referring to Federal Reserve Chair Jerome Powell's comments at the August Jackson Hole, Wyoming economics symposium suggesting an easing could come soon.

Futures markets are all but certain the Federal Open Market Committee will ease, for the first time since December, by a quarter point after next week's meeting. Traders see a small 7% chance of a larger 50 basis-point cut, talk of which picked up in the wake of last Friday's shockingly downbeat payrolls report showing only 22,000 positions were created in August.

The cool PPI report could help solidify a Fed decision to loosen policy again, but more important will be Thursday's Consumer Price Index, ahead of which markets have been reluctant to trade too much.

Also widely watched for evidence of demand for U.S. debt will be the auction of $39 billion of 10-year notes later on Wednesday and especially Treasury's $22 billion sale of 30-year bonds on Thursday.

The 30-year yield has declined by about 28 basis points since it briefly topped 5% for the first time since mid-July a week ago.

The selloff that lifted the long-bond yield to 5% immediately drew buyers. While there was little sign of concession lifting yields before the auction, it could see support following a stellar U.S. three-year note auction on Tuesday.

The yield on the benchmark U.S. 10-year Treasury note US10YT=TWEB was off 1.7 basis points at 4.057%. The yield on the 30-year bond US30YT=TWEB initially rose after the inflation data and was last off 0.2 basis points at 4.715%.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=TWEB, seen as an indicator of economic expectations, was at a positive 53.6 basis points. The two-year US2YT=TWEB U.S. Treasury yield, which typically moves in step with interest rate expectations for the Fed, fell 2.3 basis points to 3.519%.