TREASURIES OUTLOOK-U.S. yields rise after inflation data, focus on jobs next week

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* Market consolidation likely next week -BMO

* U.S. inflation data better than expected, lifts yields

* U.S. yield curve steepens after flattening for most of the week

* U.S. overnight repo rate rises from Thursday’s 8-month low

NEW YORK, Jan 29 (Reuters) - U.S. Treasury yields extended gains on Friday after data showed inflation perked up last month, while employment costs rose suggesting the world’s largest economy is on the mend from the devastating effects of the pandemic.

Next week’s U.S. non-farm payrolls report should provide more evidence about where the economy and interest rates are headed.

“Ahead of the NFP, we are biased toward an extension of the process of consolidation,” said BMO Capital in a research note. “With a period of consolidation as the path of least resistance, we’d skew the risks in favor of a retest of 99.4 basis points in 10s before another attempt to breach the upper bound of 1.186%.”

U.S. yields slowed their rise Friday afternoon as index extension month-end buying kicked in from portfolio managers.

Index extension happens when bond portfolios that track indexes are rebalanced at the end of the month.

In January, investors sold Treasuries and bought stocks. To rebalance that, investors following indexes would have to buy Treasuries and sell stocks.

Yields already were on the rise overnight, in tandem with those in Europe, after a Reuters story, citing sources, said the European Central Bank was unlikely to cut its already-record low policy rate as this would do little to revive the pandemic-hit euro zone economy.

The U.S. yield curve steepened as long yields rose following the inflation number, with the spread between 2-year and 10-year notes hitting 98.30 basis points, the widest in about a week.

U.S. data showed the personal consumption expenditures (PCE) price index, excluding the volatile food and energy component, increased 0.3% after being unchanged in November. The core PCE index is the preferred inflation measure for the Fed’s 2% target.

“Inflation was a little better than expected and trending in the right direction,” said Patrick Leary, chief market strategist, at broker-dealer Incapital.

The break-even inflation rate on 10-year Treasury Inflation Protected Securities, a gauge of expected annual inflation over the next 10 years, rose to as high as 2.089%, in wake of the PCE price data, up from 2.04% on Thursday.

A separate report from the Labor Department on Friday showed its employment cost index (ECI), the broadest measure of labor costs, rose 0.7% last quarter after advancing 0.5% in the third quarter.

In afternoon trading, the U.S. benchmark 10-year yield rose to 1.097%, from 1.055% late on Thursday. It hit a one-week high of 1.105%.

U.S. 30-year yields advanced to 1.863% from Thursday’s 1.819%, after earlier rising to a one-week peak of 1.87%.

U.S. two-year yields remained anchored, slightly down on the day at 0.117%, from 0.121% on Thursday.

In the short-term market, the U.S. overnight repo rate on Friday rose to 0.09% versus Thursday’s 0.03%, the lowest since May 2020. Since July, the repo rate has declined as much as 14 basis points, suggesting excess market liquidity.

The decline has been attributed to inflows into the repo market from government sponsored enterprises Fannie Mae and Freddie Mac at this time of the month, which should be a regular occurrence, but seemed to have a bigger-than-usual reaction. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Andrea Ricci and Richard Chang)