* Investors brush off larger-than-forecast downgrade of U.S. GDP
* U.S. seven-year note supply on track for lowest yield since October
By Richard Leong
NEW YORK, May 29 U.S. benchmark Treasury yields held near 11-month lows on Thursday ahead of a $29 billion seven-year note auction as data showed the U.S. economy shrank for the first time in three years in the first quarter.
The downgrade in business activity that resulted in first-quarter gross domestic product falling 1.0 percent stemmed largely from a huge drop in inventories. While this was steeper than forecast, it was not severe enough to change the view of a solid rebound in growth in the second quarter.
Moreover, a recent bond market rally has lowered yields to levels consistent with this level of growth, analysts said.
"The bond market is priced in for a pretty weak economy already. Everybody knew it was going to be a contraction even though it's a bigger drop than what they had thought. There's not more room for yields to move lower," said Craig Dismuke, chief economic strategist at Vining Sparks in Memphis, Tennessee.
Benchmark 10-year Treasuries yield last traded at 2.431 percent, down about 1 basis point from late Wednesday, after touching 2.422 percent, the lowest since last June.
The yield on 30-year bonds was 3.285 percent, little changed from Wednesday's close. Earlier it hit 3.278 percent, an 11-1/2-month trough.
While U.S. yields have fallen on economic worries and some safe-haven demand tied to conflict in Ukraine, analysts have attributed the appetite for longer-dated Treasuries to a combination of technical factors including month-end portfolio rebalancing and exiting bets on rising yields.
They also cited foreign investors scrambling for U.S. bonds' relatively higher yields compared to German Bunds in anticipation of the European Central Bank possibly raising interest rates next week to help the euro zone economy.
Still the extent of the bond market rally has confounded some analysts and investors even as Wall Street stock prices remain in lofty territory with the Standard & Poor's 500 index setting a record high this week.
This has complicated the decision for investors on whether to buy medium-dated Treasuries offered this week at these low yields.
At 1 p.m. (1700 GMT), the Treasury Department will complete this week's debt sales with a $29 billion seven-year note offering that followed a mediocre $35 billion auction of five-year debt on Wednesday
In the "when-issued" sector, traders expected the upcoming seven-year issue to sell at a yield of 2.016 percent, on course for the lowest yield at a seven-year auction since October. (Reporting by Richard Leong; Editing by James Dalgleish)