* Shares set for biggest weekly drop since late 2016
* BAML indicator triggers sell signal for risk assets
* Euro near multi-year peaks on yen, dollar
* Bond yields spike as inflation expectations flare
* BOJ offers to buy unlimited bonds to stop yields rising
* Bitcoin tumbles further from December's record high
By Ritvik Carvalho
LONDON, Feb 2 (Reuters) - World stocks were set to post their biggest weekly drop since late 2016 on Friday, as talk of central bank policy tightening and expectations of higher inflation boosted borrowing costs globally, a move that sparked a sell-off in shares.
The MSCI world equity index, which tracks shares in 47 countries, was down 0.4 percent. The index was set to snap its longest winning streak since 1999 - 10 weeks of gains - and record its biggest weekly loss since November 2016.
The yield on the 10-year U.S. Treasury jumped to more than 2.8 percent, its highest level since early 2014. That markedly steepened the yield curve and squeezed out investors who had feverishly bet on a tighter spread between longer-dated and short-dated yields.
Global central banks have recently struck a more hawkish tone, with impressive economic data and buoyant oil prices driving up long-term inflation expectations.
The European Central Bank, for one, is widely expected to end its asset-purchase programme as early as September. That has pushed five-year German Bund yields above zero for the first time since 2015. UK gilt prices also cheapened significantly.
The Bank of Japan did its best to stem the rise in borrowing costs, stepping into the market on Friday with a promise to buy as many bonds as it would take to keep yields low.
Some investors have also grown wary of the global equity bull run. Bank of America Merrill-Lynch's indicator of market sentiment hit a "sell" signal pointing to a downturn for risk assets, the bank's strategists said on Friday.
"If you look at a variety of indicators, it looks like we have swung to levels of extreme bullishness. We have seen substantial inflows," said Paul 'O Connor, head of UK-based Janus Henderson's multi-asset team.
"We have seen consensus crowding into the long equity trade so actually we have begun to fade the move and take some equity risk off in the last few weeks."
In currencies, after initially failing to get a boost from the pick up in U.S. Treasury yields, the dollar index had inched up 0.2 percent by noon in Europe. Still, the index, which measures the greenback against a basket of peers, was not far above its lowest levels in three years.
"Bond investors are selling out of U.S. treasuries and at the same time liquidating out of their long U.S. dollar positions," Nordea Markets Chief Analyst Niels Christensen said, explaining why the dollar had failed to gain on the spike in U.S. treasury yields.
He described the turnaround on Friday for the dollar as led by "some profit taking ahead of the US jobs numbers" and a small move.
The United States is witnessing deep partisan political divisions and intra-party squabbles with lawmakers unable to find common ground on most issues. The federal government shut down last month for three days when Republicans and Democrats failed to strike a deal to fund public operations.
Investors now await January's U.S. nonfarm payrolls report for clues on the strength of the labour market.
Nonfarm payrolls probably rose by 180,000 jobs last month after increasing 148,000 in December, according to a Reuters survey of economists. The unemployment rate is forecast to be unchanged at a 17-year low of 4.1 percent.
Bitcoin, the world's biggest cryptocurrency, continued to tumble after hitting a record high $19,666 in December on the Bitstamp exchange. It was last down 13 percent at a more than two-month trough of $7,830.
European shares were set for their biggest weekly loss in six months as a slump in Deutsche Bank on a disappointing update dragged the heavyweight banking sector lower after a strong start to the year.
A more than 5 percent drop in shares of the German lender and losses in most sectors dragged the pan-European STOXX 600 .STOXX index down 1 percent, set for its fifth straight session of declines. Germany's DAX fell 1.2 percent and the UK's FTSE dropped 0.4 percent.
The STOXX is down 2.6 percent so far this week, its biggest weekly loss since August.
Asian shares stumbled, with Korean and Japanese benchmark indices falling 1.7 percent and 0.9 percent respectively. .
MSCI's broadest index of Asia-Pacific shares outside Japan slipped 0.3 percent and away from a record high.
Wall Street futures indicated a open in the red.
In commodities, gold hovered near a six-month peak at $1,344.51 an ounce.
Oil rose after a survey showed strong compliance with output cuts by OPEC and others including Russia, offsetting concerns about surging U.S. production.
U.S. crude fell 0.1 percent to $65.73 per barrel and Brent fell 0.3 percent to $69.42.
Reporting by Ritvik Carvalho; additional reporting by Saikat Chatterjee and Tommy Wilkes in LONDON; Editing by Toby Chopra