TREASURIES-Edge lower ahead of five-year auction

* Market more sceptical about chances of Aug rate rise

* Some concern about prospects for five-year auction

By Masayuki Kitano

TOKYO, June 26 (Reuters) - U.S. Treasuries mostly fell on Thursday as market players prepared for a five-year note auction, but two-year notes held steady after traders scaled back bets of an imminent Federal Reserve interest rate hike. The Fed held rates at 2 percent on Wednesday, as widely expected, and voiced greater concern about inflation, taking a small step down a path toward higher borrowing costs. [ID:nFEDAHEAD]

Treasuries initially fell on Wednesday after the announcement, but later reversed course as traders scaled back expectations for a rate hike at the Fed's next meeting in August.

"The Fed seems to be keeping in mind the possibility of an interest rate rise down the road," said Yasutoshi Nagai, chief economist for Daiwa Securities SMBC's economic research group.

But traders are likely starting to have some doubts about the chances of a Fed rate rise within the next few months, he said, adding that the central bank would likely hold rates steady for the rest of the year.

The benchmark 10-year Treasury note fell 2/32 in price to yield 4.111 percent US10YT=RR, up 1 basis point from late U.S. trading on Wednesday.

The five-year note dipped 1/32 in price to yield 3.536 percent US5YT=RR, up 1 basis point from late New York.

But the two-year note, the sector most sensitive to shifts in the outlook for monetary policy, was steady in price for a yield of 2.822 percent US2YT=RR.

The Treasury will auction $20 billion in five-year notes later on Thursday.

"Bidding at the auction might not be very active at these levels," Nagai said. The five-year yield has already dropped more than 20 basis points in the past couple of weeks.

Although the market has been pricing in the likelihood of a Fed rate rise by September, analysts have been more sceptical, since the impact of tax rebates may wear off around then and due to the proximity to the U.S. presidential election in November, Nagai said.

U.S. interest rate futures on Wednesday showed that traders see a roughly 35 percent chance of the Fed raising rates in August, down from around 50 percent before the Fed's rate decision. But they remain certain of a rate increase by September. See [ID:nN253247]

Such implied probabilities contrast with the expectations of Wall Street economists, who largely expect the Fed to keep short-term interest rates on hold in coming months, according to a Reuters poll taken after the Fed's rate decision.

The median forecast of the economists that took part in the survey was for the central bank to keep rates at 2 percent for the rest of the year. [FED/R]

(Editing by Brent Kininmont)