* Benchmark yields set for first weekly drop since April * TIPS recover after U.S. producer prices rise in May * Futures suggest traders pricing out Fed hike before 2014 * Data point to sluggish U.S. growth, mild inflation By Richard Leong NEW YORK, June 14 (Reuters) - U.S. government debt prices rose on Friday as traders bet the Federal Reserve would keep interest rates near zero for a protracted period to help the economy even if the bank slows its bond buying this year. Supporting that view, a Wall Street Journal report on Thursday said a change in the Fed's bond-buying does not mean that the U.S. central bank would end the purchases "all at once" or that the Fed was "anywhere near raising short-term interest rates." The article soothed market fears that the U.S. central bank was preparing for a quick exit from the quantitative easing policy it adopted more than four years ago. The Fed has been buying bonds with the goal of lowering long-term interest rates. Markets have fretted about that possibility since Fed head Ben Bernanke, in congressional testimony on May 22, said the bank could decide reduce its current $85 billion monthly bond purchases at one of the "next few meetings" if the economy proves on a steady growth path. "It's important for the Fed to reposition the market to think that a rate increase is at least two years away," said Justin Hoogendoorn, fixed income strategist at BMO Capital Markets in Chicago. Short-term interest rates futures jumped in the wake of the Wall Street Journal report, suggesting traders dialed back bets that the Fed might raise rates next year. The Dec 2014 federal funds contract implied traders anticipated a 42 percent chance of a Fed rate hike at the end of next year, down from 47 percent on Thursday, according to CME Group's FedWatch, which computes traders' expectations on the fed funds rate that the Fed influences through monetary policy. A month ago, that contract implied a 26 percent chance of a rate increase at the Fed's Dec 2014 policy meeting. Fed policymakers, who will meet Tuesday and Wednesday, might offer more clues about their collective view on the current third round of bond purchases, known as QE3. "That (Wall Street Journal) article put things back into perspective. Next week, the market is looking for clues about possible timing on a tapering," said Sean Simko, head of fixed income management at SEI Investments Co. in Oaks, Pennsylvania. Reduced anxiety about the Fed raising short-term rates, together with, on balance, weaker-than-expected data on industrial output and consumer sentiment, spurred buying in Treasuries, sending benchmark yields to their lowest levels in a week. The yield on 10-year Treasury notes tracked its first weekly decline since late April. This would snap the longest weekly losing streak for the 10-year note since late March to early May 2009, when its yield rose for seven straight weeks, according to Reuters data. The 10-year note last traded 6/32 higher in price with a yield of 2.13 percent, compared to 2.1579 percent late on Thursday. The 30-year bond rose 8/32 to yield 3.3 percent, from 3.313 percent late on Thursday. Treasury yields rose to 14-month highs earlier this week on fears about the Fed buying fewer bonds. The bond market stabilized from its recent sell-off as data showed the U.S. economy is growing only sluggishly. Federal budget cuts and expiration of a payroll tax holiday have added to a drag on growth this year. "The Fed is trying to lay down a road map, but the market has over-reacted," Simko said. Data on Friday showed industrial output was unchanged in May, falling short of the 0.2 percent rise forecast by economists, while the Thomson Reuters and University of Michigan said their index on U.S. consumer sentiment unexpectedly fell from a near six-year high in early June. While these latest reports signaled a U.S. economy struggling to gather steam, government data showed domestic price growth, while weak, was not at the precipice of deflation, a downward price spiral that had crippled Japan for a decade. The U.S. producer price index grew 0.5 percent last month, more than the 0.1 percent gain projected by analysts. The inflation news helped bolster Treasury Inflation Protected Securities, which had been pummeled since early April by heavy selling on falling inflation expectations and fears over reduced bond purchases from the Fed. The yield on 10-year TIPS briefly fell below zero percent before returning into positive territory. On Monday, the 10-year TIPS yield traded above zero for the first time since January 2012, according to Reuters data. Separately, at 11:00 a.m. (1500 GMT), the Fed bought $1.46 billion in Treasuries whose maturities range from February 2036 through May 2043.