* 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 bought bonds on the view the Federal Reserve would stick to its near-zero interest rate policy for a protracted period to help the economy even if it reduces its bond purchases this year. That view emerged after a Wall Street Journal report on Thursday which said an adjustment in the Fed's bond-buying program did 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 allayed the market's worst 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. Those worries grew out of comments from Fed Chairman Ben Bernanke at a testimony before a congressional panel on May 22, when he said a decision on whether to reduce its current $85 billion monthly bond purchases could come at one of the central bank's "next few meetings" if the economy proves it's 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 of a rate increase at the Fed's Dec 2014 policy meeting. Fed policy-makers, 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 was on track for 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 11/32 higher in price with a yield of 2.108 percent, down 4.1 basis points from late on Thursday. The 30-year bond rose 21/32 to yield 3.279 percent, 3.4 basis points lower than Thursday's close. 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, while growing, has been unable to gain traction due to high unemployment. Federal budget cuts and expiration of a payroll tax holiday have added to the 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, a government report 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.