TREASURIES-US yields drop after producer prices data signals lower inflation

Recasts, updates prices; adds US data, byline, previous dateline LONDON

By Gertrude Chavez-Dreyfuss and Amanda Cooper

NEW YORK/LONDON, Feb 13 (Reuters) - U.S. Treasury yields fell on Thursday after certain components in the January Producer Price Index pointed to lower inflation, suggesting that the Federal Reserve remained on track to cut interest rates later this year.

U.S. PPI rose 0.4% after an upwardly revised 0.5% gain in December, but key elements in the computation of the core Personal Consumption Expenditures (PCE) index, which the Fed tracks, were actually benign or lower.

Components like physician's office and hospital prices were either broadly unchanged or rose just slightly. Healthcare, with a nearly 20% weighting in the core PCE, declined 0.06%.

Portfolio management prices, another important item on core PCE, posted a modest 0.4% increase.

"It looks like core PCE will come out at around 0.3%, which is still high, whereas in January of last year, it was 0.5%. If that forecast is correct, core PCE is going to fall from 2.8% to 2.6% year over year," said Chris Diaz, co-head of fixed income at Brown Advisory in Chicago.

The Fed will be able to cut rates more than the market expected, he said. "There's going to be enough downward pressure in the shelter component and wages that will continue to put downward pressure on inflation."

Following the PPI data, U.S. rate futures priced in 31 basis points (bps) of easing this year, compared with 27 bps late on Wednesday, according to LSEG calculations. The next rate reduction is expected either at the October or December meeting.

The benchmark 10-year yield slid 8.9 bps to 4.544% US10YT=RR after hitting a roughly three-week high on Wednesday. U.S. 30-year yields also fell, down 7.6 bps at 4.758% US30YT=RR.

The two-year yield, which reflects Fed policy moves, was down 4.8 bps at 4.317% US2YT=RR. On Wednesday, the yield rose to its highest since mid-January of 4.389%.

The PPI report followed data on Wednesday that showed the Consumer Price Index rose at an annual rate of 3.0% in January, up from 2.9% in December and above forecasts for a rise of 2.9% year-on-year.

Energy, food and shelter prices all contributed to the increase. The core rate, which excludes food and energy, also rose more than expected.

The U.S. Treasury, meanwhile, is set to auction $25 billion in 30-year bonds on Thursday. Analysts said the bond looks fairly valued and would require a major concession or sell-off for the auction to be absorbed successfully.

In other parts of the bond market, the U.S. two-year breakeven inflation rate USBEI2Y=RR rose to 3.338%, the highest since the summer of 2022, before easing to around 3.16% and well above the Fed's 2% target for consumer inflation.

The rate is derived by subtracting the inflation-linked two-year Treasury yield from that of the nominal two-year note US2YT=RR.

U.S. President Donald Trump is on the verge of announcing another round of tariffs, which many believe will contribute to a sustained rise in inflation, as the price of imports increases.