U.S. TIPS imply traders see minimal deflation

NEW YORK, Nov 4 (Reuters) - The 10-year yield spread on U.S. inflation-protected securities and regular Treasuries grew to its widest level since before the demise of Lehman Brothers, the most tumultuous chapter of last year's credit crisis.

The break-evens between benchmark 10-year government notes US10YT=RR and 10-year Treasury Inflation-Protected Securities US10YTIP=TWEB grows with declining deflation worries.

TIPS break-evens are watched by traders and the Federal Reserve as proxies of the market's inflation/deflation expectations.

Lehman's collapse last September roiled financial markets and spurred fears of a long period of price declines that contributed to shrinkage in the economy.

Break-evens grew initially on Wednesday after the U.S. Treasury Department announced it will sell a record $81 billion in bonds at next week's quarterly refunding. The government's burgeoning borrowing fanned inflation worries.

Break-evens expanded further in afternoon trading in reaction to the Federal Reserve's pledge to stick to its near zero interest rate policy to foster economic growth, but some traders fear this move could result in a resurgence in inflation.

"The Fed is on hold for a little longer and to some that may be raising concern about the risk of policy mistake down the road," said John Canally, economist with LPL Financial in Boston.

The break-evens between 10-year TIPS and regular Treasuries were last quoted at 210 basis points, up 7 basis points from late Tuesday. This was the widest level since August 2008.

(Reporting by Richard Leong; Editing by Dan Grebler)