By Susanne Walker and Cordell Eddings Feb. 19 (Bloomberg) -- Treasuries advanced after a government report showed the cost of living in the U.S. rose less than forecast in January from a month earlier while so- called core prices unexpectedly dropped. U.S. securities gained for the first time in three days as the Labor Department said the consumer price index increased 0.2 percent last month, compared with a forecast in a Bloomberg survey for a rise of 0.3 percent. Excluding energy and food, prices fell 0.1 percent. Federal Reserve Bank of St. Louis President James Bullard said yesterday the central bank may not lift the benchmark interest rate until 2011. “Inflation remains well behaved, as it should given low rates of capacity utilization and high levels of unemployment,” said Donald Ellenberger, who oversees about $6 billion as co- head of government and mortgage-backed securities at Federated Investors in Pittsburgh. “There was a little bid to the market, but there is still the concern of the supply that has to be taken down next week.” The 2-year note yield fell two basis points, or 0.02 percentage point, to 0.91 percent at 8:50 a.m. in New York, according to BGCantor Market data. The gap between two- and 10- year yields, the so-called yield curve, was 2.90 percentage points after touching a record 2.94 percentage points yesterday. Treasuries declined yesterday after the Federal Reserve raised the discount rate charged to banks for direct loans for the first time in more than three years to encourage financial institutions to rely less on the central bank for short-term borrowing. Two-year note yields, the most sensitive to monetary policy, climbed as much as nine basis points to touch 0.93 percent, the highest level in three weeks. Discount Rate The yield curve earlier steepened as reports showed that Philadelphia region manufacturing and U.S. leading indicators rose. The Treasury said it will sell $126 billion in notes and bonds next week. The discount rate increase to 0.75 percent from 0.50 percent action is effective on Feb. 19. It is another step in the Fed’s gradual retreat from its unprecedented actions to halt the deepest financial crisis since the Great Depression. The central bank has provided hundreds of billions of dollars in backstop credit to banks, bond dealers, commercial paper borrowers and troubled financial institutions such as American International Group Inc. The Federal Reserve Board said yesterday the outlook for policy remains “about as it was at the January meeting of the Federal Open Market Committee.” It also cited last month’s committee statement, which said economic conditions are likely to warrant “exceptionally low” levels of the federal funds rate “for an extended period.” Bullard’s Outlook The target rate for overnight bank lending has been in a range of zero to 0.25 percent since December 2008. Bullard of the St. Louis Fed said in response to audience questions after a speech in Memphis, Tennessee, that he doesn’t see a high probability the central bank will raise the federal funds rate this year. The U.S. said it will sell next week $8 billion in 30-year Treasury Inflation Protected Securities, or TIPS, $44 billion in 2-year debt, $42 billion in 5-year notes and $32 billion in 7- year securities. The auctions will be on successive days starting Feb. 22. The difference between yields on U.S. 10-year notes and comparable inflation-indexed debt, a measure of traders’ outlook for consumer prices, was 2.31 percentage points before the report. That compared with 2.49 percentage points on Jan. 11, the widest since July 2008. Treasury Inflation Protected Securities, or TIPS, have returned 0.27 percent in 2010, compared with 0.9 percent for conventional Treasuries, according to indexes compiled by Bank of America Merrill Lynch Securities. They returned 10 percent last year as investors sought to shield their investments from rising prices, versus an average loss of 3.7 percent for conventional securities, according to Bank of America Corp. Merrill Lynch indexes. To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net.

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