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(Refiles to fix Reuters Instrument Code for 10-year note in penultimate paragraph)
* Fed's Dudley says Fed may shrink balance sheet this year
* U.S. annual inflation rose most in five years
* Treasuries also supported by month-end buying
By Gertrude Chavez-Dreyfuss
NEW YORK, March 31 (Reuters) - U.S. Treasury debt yields fell on Friday after a chorus of Federal Reserve officials questioned the need for a faster pace of interest rate increases given tame inflation and just modest growth in the U.S. economy.
Treasury prices, which move inversely to yields, were also supported by institutional investor buying to meet routine month-end and quarter-end portfolio adjustments, analysts said.
New York Fed President William Dudley, St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari said on Friday they expect rate increases this year, but each struck a cautious tone about the U.S. economy. Investors are currently pricing in two more interest rate increases in 2017 after the Fed raised rates at its last policy meeting.
Dudley, who is also the vice chairman of the Federal Open Market Committee and a known supporter of low interest rates, said the Fed is not in a huge rush to tighten policy since the economy is not overheating. Bullard echoed the sentiment, as did Kashkari.
Jennifer Vail, head of fixed income of The Private Client Reserve, at U.S. Bank in Portland, Oregon said the Fed officials' remarks, specifically from Dudley and Bullard, helped pushed yields lower.
"When Dudley speaks, given his role in the FOMC, it kind of eclipses many of the other folks that speak in the marketplace," said Vail.
All three officials also pushed for shrinking the Fed's balance sheet, with Dudley saying the Fed could actually do so this year, earlier than what most economists have expected.
Comments on shrinking the balance sheet, which Dudley said was tantamount to raising rates, steepened the yield curve, after a flattening trend the last two weeks.
The gap between the yields of shorter-dated and longer-dated Treasuries widened on Friday, with the spread between the two-year and 10-year notes rising to as much as 115.10 basis points, the steepest in a week.
Shrinking the balance sheet typically leads to a steeper yield curve. Allowing Treasury bonds and notes to roll off without replacing them with new ones while keeping the fed funds rate relatively low, would cause long-term rates to rise sharply while putting a lid on short-term rates.
U.S. economic data on Friday, meanwhile, was a mixed bag, with the rise in year-on-year inflation to a nearly five-year high, a stronger-than-expected factory activity in the U.S. Midwest and easing consumer sentiment for March.
The report backed the Fed's view that the U.S. economy is growing at a steady, but not a rapid pace.
In late trading, U.S. 10-year notes were up 6/32 in price to yield 2.396 percent, compared with 2.418 percent on Thursday.
U.S. two-year note yields were at 1.257 percent, down from 1.286 percent late on Thursday. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Steve Orlofsky)