TREASURIES-Prices fall, yield curve steepens on inflation risk

* Yield curve steepens from five-year lows

* Benchmark 10-year note yields highest in four weeks

* Inflation risk seen as labor costs rise

By Karen Brettell

NEW YORK, July 31 (Reuters) - U.S. Treasuries yields rose on

Thursday as rising labor costs led some investors to prepare for

a greater likelihood that the Federal Reserve will increase

interest rates next year, while others feared that inflation may

be a higher risk if the U.S. central bank is too slow to hike

rates.

Data on Thursday showed that U.S. labor costs recorded their

largest increase in more than 5-1/2 years in the second quarter,

a sign that a long-awaited acceleration in wage growth was

imminent.

The data comes after gross domestic product on Wednesday

showed a strong rebound in the second quarter from a weak start

to the year.

"Starting with GDP yesterday, it certainly set things off,"

said Ira Jersey, an interest rate strategist at Credit Suisse (NYSE: CS - news) in

New York. "In general, you have decent data and if the Fed's

behind the curve, you will wind up with inflation running a

little bit higher than people thought."

The yield curve steepened as investors adjusted to the

prospect of higher inflation. The yield gap between five-year

notes and thirty-year bonds steepened to 156 basis points, up

from a five-year low of 149 basis points on Wednesday.

Benchmark 10-year notes fell 10/32 in price to

yield 2.60 percent, the highest since July 8.

The Fed reiterated on Wednesday that it would likely keep

rates near zero for a "considerable time" after its bond buying

ends and restated that an "accommodative" policy was needed in

the statement from its July meeting.

The central bank acknowledged higher prices but also

expressed concern about remaining slack in the labor market.

Many expect that the Fed will adopt a more hawkish tone and

offer more details about its exit strategy when it next meets in

September. The Fed is now evaluating a wide range of employment

data as guides for interest rate policy, however, which may also

keep it on hold for longer.

Higher yields since Wednesday's GDP data indicated traders

are pricing for higher inflation or the likelihood that the Fed

will raise rates next year if the economy continues to improve.

A Morgan Stanley (Xetra: 885836 - news) index meant to gauge the timing of the

first interest rate hike (M1KE) on Wednesday suggested that an

increase may occur within 12 months, the first time since 2011

that the index has indicated one will occur within a year, an

analyst at the bank said in a report on Wednesday.

Based on this indicator, two-year note yields should pay

0.68 percent, the bank added. That is 10 basis points higher

than the notes' current yield of 0.58 percent.

The next major focus will be Friday's jobs report for July.

Employers are expected to have added 233,000 jobs in July

according to the median estimate of 100 economists polled by

Reuters.

(Editing by Nick Zieminski)