TREASURIES-US yields sink after subdued August inflation data

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U.S. 10-year yields on track for largest daily fall in two weeks

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U.S. two-year yields on pace for worst day in 11 days

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U.S. rate futures imply 80 bps in cuts for rest of 2024

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U.S. PCE index rise slows in August

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Univ. of Michigan consumer sentiment improves

(Adds comment, graphic, news on Israel attack, updates prices)

By Gertrude Chavez-Dreyfuss

NEW YORK, Sept 27 (Reuters) - U.S. Treasury yields fell on Friday after data showed inflation in the world's largest economy continued to ease, boosting the chances of an outsized interest rate cut at the Federal Reserve's November policy meeting.

Ongoing conflict in the Middle East, with Israel's attack in Lebanon, also pushed Treasury prices higher in a flight-to-quality bid, pressuring their yields, analysts said. The Israeli military said it had targeted Hezbollah's central headquarters in Beirut's southern suburbs on Friday in an attack that shook the Lebanese capital and sent thick clouds of smoke over the city.

The benchmark 10-year yield slid 3.8 basis points to 3.751% , on pace for its worst daily fall in two weeks. The 10-year yield had been on a general uptrend since the Fed cut interest rates by 50 basis points (bps) on Sept. 18.

Some analysts though attributed the rise to technical factors, with Treasury yields having declined sharply for several weeks prior to the Fed's move in anticipation of the first rate cut in more than four years.

But that uptrend shifted after Friday's data showing that the personal consumption expenditures (PCE) price index, the Fed's favored inflation measure, rose 0.1% in August after an unrevised 0.2% gain in July. Economists had forecast PCE inflation at 0.1%. In the 12 months through August, the PCE price index increased 2.2% after rising 2.5% in July.

"The PCE was generally in line with the trend of inflation decelerating," said Bill Merz, head of capital markets research, at U.S. Bank Asset Management in Minneapolis.

"Inflation remains a bit higher than the Fed would like but it is still moving in the right direction for now. We think long-end yields are within the range that makes sense given the pattern of data that we have seen," he added.

The U.S. 30-year yield slipped 2.1 bps to 4.101% , posting its worst day-to-day fall in a week.

On the shorter end of the curve, the two-year yield was down 6 bps to 3.563%, on track for its largest daily decline in 11 days.

Treasury yields slipped further after the latest University of Michigan consumer sentiment survey revealed an upwardly revised increase to 70.1 in the final September reading, a five-month peak, from 67.9 in August. The one-year inflation outlook also dipped to 2.7% from August's 2.8%.

The fact that the Michigan's survey's inflation outlook underscored the PCE data gave reason for bond investors to nudge yields a little lower.

In other parts of the Treasury market, the yield curve steepened in the wake of the PCE data, with the spread between two-year and 10-year yields hitting 18.8 bps. It was last at 18.4 bps.

On Friday, the curve showed a bull steepening scenario, in which rates on the front end are falling more sharply than those longer-dated maturities. A bull steepener suggests that more interest rate cuts are underway.

The U.S. rate futures market has priced in a 54% chance of a 50-bp cut in November, up from about 49% before the release of the data, according to LSEG calculations. The chances of a 25 bps move slid to 46% after the inflation data, from 51% pre-PCE report.

For the next two meetings in November and December, the futures market now expects 80 bps in policy easing.

The size of the rate cut in November would "depend on the path of the labor market," said Michael Brenner, research analyst at investment advisory firm FBB Capital Partners.

"If we see payrolls start to pick up and we see more strength in the labor market, the Fed can back off and just do 25 basis points, which is more in line with the SEP (Summary of Economic Projections). If we continue to see weak jobs reports, it will make the probability of a 50 basis-point cut higher."

(Reporting by Gertrude Chavez-Dreyfuss; Editing by Nick Zieminski and Andrea Ricci)