TREASURIES-Bonds fall as investors ponder pending supply

* Investors begin to make room for next week's note supply

* U.S. to sell $44 bln 2Y, $42 bln 5Y, $32 bln 7Y debt

* CPI shows no inflation; Philly Fed index rises a tad (Adds analyst's quote, updates prices, changes byline)

By Chris Reese

NEW YORK, March 18 (Reuters) - U.S. Treasuries fell on Thursday as investors cleared room for next week's supply, overshadowing tame inflation data that reinforced the view the Federal Reserve can leave short-term interest rates near zero percent.

The Treasury Department, as expected, said it will sell $44 billion in two-year notes, $42 billion in five-year debt, and $32 billion in seven-year notes next week.

The amounts matched what it sold in February as the government seeks to finance its huge deficit. Ahead of the sales, investors moved to force some concession in prices.

"Supply pressures are significant after (the Treasury) announced next week's Treasury supply," said John Canavan, analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.

Benchmark 10-year Treasury notes US10YT=RR traded 8/32 lower in price to yield 3.67 percent, up from 3.64 percent late Wednesday, while two-year notes US2YT=RR were down 3/32 to yield 0.96 percent, up 4 basis points from late Wednesday.

"It will be hard for the market to digest the supply at these levels," said Larry Milstein, head of government and agency trading with R.W. Pressprich & Co. in New York.

The spread between yields on 10-year notes and two-year notes, a gauge of the market's inflation expectations, narrowed to 270 basis points, the tightest level so far this year.

The market initially was buoyed by a revived safety bid tied to Greece's fiscal problems but was unable to hold gains, snapping bonds' four-day winning streak. For details see [ID:nLDE62H0LL].

Treasuries also had some early support from inflation news. The U.S. Labor Department said its Consumer Price Index was unchanged in February from January, and the core rate, which excludes energy and food prices, rose 0.1 percent. [ID:nN18215395]

The CPI reading came a day after the government said the Producer Price Index posted its biggest monthly drop in seven months in February. The Fed on Tuesday renewed its pledge to hold short-term interest rates near zero to support the economic recovery.

The yield gap between the regular 10-year notes and 10-year Treasury Inflation-Protected Securities shrank 1 basis point to about 2.23 percent, signaling investors expect inflation will remain low.

Investors' view of tame inflation did not change despite a slightly higher-than-expected reading on business activity from a regional Federal Reserve Bank.

The Philadelphia Fed said its index on business activity in the U.S. Mid-Atlantic region rose to 18.9 in March from 17.6 in February. Analysts had predicted a reading of 18.0.

Five-year Treasury notes US5YT=RR traded 7/32 lower in price to yield 2.42 percent, up from 2.37 percent late Wednesday, while 30-year bonds US30YT=RR were 8/32 lower to yield 4.59 percent from 4.57 percent. (Additional reporting by Richard Leong; Editing by Kenneth Barry)