U.S. 10-year Treasury notes had their biggest weekly drop since May as rising commodity prices and increased consumer demand for imported goods bolstered speculation inflation will accelerate.

Investors pushed down government debt prices on concern faster inflation will erode the value of fixed-income payments. The tumble drove up yields and led to higher borrowing costs for consumers and companies. Some investors expect the rise in yields to continue.

``Rates are going to rise gradually over the rest of the year,'' said Gary Pollack, head of fixed income trading and research at Deutsche Bank Private Wealth Management in New York, which manages $12 billion of bonds.

The benchmark 4 percent security due in February 2015 declined about 1 7/8, or $18.75 per $1,000 face amount, to 95 23/32 in New York, according to bond broker Cantor Fitzgerald LP. The yield rose 24 basis points to 4.54 percent. A basis point is 0.01 percentage point. The yield on March 10 reached 4.56 percent, the highest since July. The benchmark two-year note yielded 3.72 percent, the highest in almost three years.

Higher Treasury yields caused the average fixed rate on a 30- year mortgage to climb this week to 5.85 percent, the highest since August, Freddie Mac said. Companies sold about $9 billion in debt in the U.S. this week, less than the $15 billion average this year.

Trade Deficit

The declines started March 8 as oil and gasoline prices neared record highs and commodity prices as measured by the Reuters-CRB index hit a 24-year high.

The week ended with a Commerce Department report showing the trade deficit was $58.3 billion in January, more than the median estimate of $56.8 billion in a Bloomberg survey of economists, and the second-largest ever. Demand for consumer goods, automobiles and business equipment pushed imports to a record.

Yesterday's data ``contributes to the current reassessment in the market that the (Federal Reserve) has a long inflation battle on its hands and it does not appear that the fight is anywhere near over,'' said Sadakichi Robbins, head of proprietary fixed-income trading at Bank Julius Baer & Co. in New York.

Trade Deficit

There is a growing risk the Fed will raise rates by a half- percentage point at either its May 2 or June 30 meeting, John Herrmann, director of economic commentary at Cantor Viewpoint, said in a research note this week. The Fed has raised rates in six quarter-point increments since June.

``The low inflation environment might be behind us,'' said Alex Li, an interest-rate strategist in New York at Credit Suisse First Boston, one of the 22 primary U.S. government securities dealers that trade with the Fed's New York branch. Ten-year yields may rise to 5 percent by year-end, he said.

A wider U.S. trade gap means more dollars need to be converted to other currencies to pay for imports. Against the euro, the dollar has its biggest weekly decline since December, is near the weakest since the first week in January.

Yield Forecast

Ten-year note yields may reach as high as 4.75 percent in the next couple of months, said Ralph Axel, a U.S. government debt strategist in New York at HSBC Securities USA Inc., a unit of Europe's biggest bank by market value.

A major concern for Treasuries is ``the weaker dollar and the inflation piece of that story,'' said Axel, whose firm is also a primary dealer. ``Inflation is the main issue of uncertainty in the U.S.''

Fed Chairman Alan Greenspan said this week a weakening dollar may prompt foreign exporters to raise prices in the U.S., spurring inflation concerns. A lower dollar may make imported goods more expensive in the U.S., Greenspan told the Council on Foreign Relations Annual Corporate Conference in New York.

``We may be approaching a point, if we aren't already there, at which exporters to the United States, should the dollar decline further, would no longer choose to absorb a further reduction in profit margins,'' Greenspan said.

Rising Expectations

Signs of labor market strength may add to expectations inflation is quickening. A Fed survey on March 9 showed companies ``indicated greater ease in passing along price increases.''

In the past month, government reports have shown the producer price index excluding food an energy rose the most since 1998 in January, the core consumer price index increased that month from a year earlier by the most since 2002. Traders and investors are raising expectations for how much the central bank will increase its target for the overnight lending rate this year.

The Fed, which has raised borrowing costs six times since June, will lift the rate to 3.75 percent by Dec. 31, according to the median forecast of 66 economists polled by Bloomberg from March 1 to March 8. The rate is now 2.50 percent.

Declines in Treasuries may be limited as some investors find value in 10-year yields at their highest since July.

Bill Gross, chief investment officer at Pacific Investment Management Co. and manager of the world's biggest bond fund, said March 10 his firm bought ``a billion or two'' dollars worth of five- and 10-year notes in recent days.

Reserves

``Given that the market looks oversold, we are positioning ourselves for some form of a near-term recovery in Treasuries,'' said Nick Tribe, at Portfolio Partners Ltd. in Melbourne, which manages the equivalent of $2.7 billion in bonds and cash. ``We are moving to be long in U.S. Treasury markets.''

Treasuries fell in Asian trading after Japanese Prime Minister Junichiro Koizumi said his country, which holds the world's largest currency reserves, should consider diversifying how it invests its foreign reserves.

Japanese Finance Minister Sadakazu Tanigaki later said the remarks don't mean the government plans to change its asset mix. Japan is the largest overseas holder of U.S. Treasuries, owning a total of $711.8 billion as of December.

China's central bank cut the share of its currency reserves held in dollars and raised its holdings of euros, according to a report by Lehman Brothers Holdings Inc. China is the second- largest foreign holder of Treasuries. It slowed its purchases of the securities in the last three months of 2004.

Seventy-six percent of China's reserves, the world's second- largest, were in dollars last year, down from 82 percent in 2003, Lehman said in an analysis yesterday of figures published by the People's Bank of China. The rest are in euros, said Lehman, the fifth-largest U.S. securities firm.

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