TREASURIES-Bonds jump on soft inflation, consumer data

* U.S. CPI, U. Mich data fan low inflation/growth view

* Post-refunding relief fuels safe-haven demand for bonds

* U.S. industrial output rises more than expected in July (Updates market action)

By Richard Leong

NEW YORK, Aug 14 (Reuters) - U.S. Treasury debt prices rallied on Friday after data suggesting tame U.S. inflation and a report showing a surprise worsening in consumer sentiment sparked an investor rush into the safety of bonds from stocks.

The figures reinforced the notion that the Federal Reserve -- the U.S. central bank -- will keep benchmark interest rates near zero and maintain its quantitative easing policy for a long time even if the U.S. economy emerges from the worst downturn in 70 years.

"It's a touch-and-go situation. There's definitely an element of insecurity" with U.S. consumers, said Ron D'Vari, chief executive at NewOak Capital in New York. "Some people see value in bonds here."

Friday's bond-friendly data followed a strong auction for $15 billion in 30-year Treasury bonds. An upbeat end to the Treasury's record $75 billion quarterly refunding bolstered the view of solid foreign demand for U.S. assets, analysts said.

The Consumer Price Index, the broadest U.S. inflation gauge, was unchanged in July, matching analysts' forecasts.

On a year-over-year basis, it was down 2.1 percent in July. "This negative CPI print is really good news for Treasuries," said William Hornbarger, senior fixed-income strategist with Wells Fargo Advisors in St. Louis, Missouri.

A stronger-than-expected reading on industrial output, which grew 0.5 percent in July, briefly tempered the rally.

The price on benchmark 10-year Treasury notes US10YT=RR was up 21/32 at 100-26/32. Their yield, which moves inversely to price, was 3.53 percent, down from 3.60 percent late on Thursday and 3.76 percent a week ago.

INFLATION CONCERNS EASE

The breakevens, or yield spread, between 10-year notes and 10-year Treasury Inflation-Protected Securities US10YTIP=TWEB narrowed to 1.72 percent -- the tightest since mid-July -- from 1.80 percent late Thursday.

The 10-year breakevens is a proxy for investors' long-term inflation expectations. This compares with the year-over-year increase of 1.5 percent on the CPI core rate, which excludes volatile energy and food prices, in July.

Another market measure of inflation expectations also shrank after the tame CPI reading. The spread between two-year and 10-year note yields compressed to 2.48 percent from 2.55 percent a week earlier.

The yield on 30-year bonds US30YT=RR sold on Thursday was 4.38 percent, below the high or clearing yield of 4.54 percent at the auction.

Major Wall Street indexes fell more than 1.5 percent on economic concerns in the wake of the weaker-than-expected data in the Reuters/University of Michigan Surveys of Consumers, adding fuel to the rally. For more see [ID:nN14304237].

OUTLOOK DOWNGRADED

Analysts downgraded their outlook on a rapid recovery after this week's snapshots on the consumer sector, which accounts for 70 percent of the U.S. economy.

The Reuters/University of Michigan index of consumer sentiment declined to 63.2 in early August, short of the 68.5 reading predicted by analysts. [ID:nN14294408]

"It's a dismal reading," said Cary Leahey, an economist with Decision Economics in New York. U.S. consumers "are just getting more and more nervous," he said.

Just a week ago, a better-than-expected July jobs report that showed a smaller-than-expected payroll decline raised market confidence in a speedy economic rebound. (Additional reporting by Ellen Freilich and Chris Reese; Editing by James Dalgleish)