* June CPI rose 3.5% on year-over-year basis, down 0.4% on

the month

* July rate hike expectations tumble

* Fed's Warsh says central bank has not satisfied price

stability mandate

(Updates to afternoon trading)

By Chuck Mikolajczak

NEW YORK, July 14 (Reuters) - U.S. Treasury yields declined

on Tuesday after data showed consumer inflation slowed more than

expected in June, dampening market expectations for a near-term

rate hike from the Federal Reserve.

The Labor Department said the Consumer Price Index increased

3.5% in the 12 months through June after surging 4.2% in May,

the largest year-on-year rise since April 2023. On a monthly

basis, CPI fell 0.4% after a 0.5% increase in May. Economists

polled by Reuters had forecast the CPI would rise 3.8% on a

year-over-year basis and dip 0.1% on a monthly basis.

"This (report) is a bit of a surprise. And obviously, it all

reflects one thing, the fall in energy prices," said Peter

Cardillo, chief market economist at Spartan Capital Securities

in New York.

"This should help relieve some worries in the bond market,

and it should give some wiggling room for the Fed."

Yields pared declines however, as Federal Reserve Chairman

Kevin Warsh gave testimony to the House Financial Services

Committee and said today's data does not mean the central bank

has satisfied its price stability mandate.

The yield on the benchmark U.S. 10-year Treasury note

fell 3.1 basis points, on pace for its biggest

daily drop since June 24, to 4.579%, after falling to 4.525%.

OIL CLIMBS AS MIDDLE EAST HOSTILITIES RISE

Energy prices have come down in recent weeks on expectations

that a durable peace deal could be reached between the U.S. and

Iran. However, hostilities have intensified in recent days and

caused a reversal in crude prices.

U.S. crude rose 0.96% to $78.90 a barrel and Brent

advanced to $84.27 per barrel, up 1.16% on the day.

The two benchmarks touched four-week highs after the U.S.

reimposed a naval blockade of Iran and as renewed attacks

between Washington and Tehran exacerbated supply concerns but

pared gains after U.S. President Donald Trump backed off his

recent announcement to charge a 20% fee to guard the Strait of

Hormuz.

The yield on the 30-year bond dipped 1 basis

point to 5.088% after dropping to 5.051%.

FED RATE HIKE EXPECTATIONS TUMBLE

Expectations for a rate hike of at least 25 basis points from

the Fed at its July meeting tumbled to 16.6% from 41.7% in the

prior session, according to CME Group's FedWatch tool. For the

central bank's September meeting, markets are pricing in a 59.8%

chance of a hike, down from 75.1% on Monday.

"This was a very encouraging inflation report that should

tamp down what seemed to be a growing chorus of folks looking

for them to hike at the July meeting," said Tom Porcelli, chief

economist at Wells Fargo, in a note.

A closely watched part of the U.S. Treasury yield curve

measuring the gap between yields on two- and 10-year Treasury

notes, seen as an indicator of economic

expectations, was at a positive 37.9 basis points.

Several Fed officials have in recent weeks flagged concerns

about inflation pressures while playing down any labor market

worries. Chicago Federal Reserve President Austan Goolsbee said

Tuesday's data was "surprisingly benign" and "encouraging" but

that one month's data is not enough to convince him inflation is

headed back to 2%.

Barclays U.S. economist Pooja Sriram said in a note that the

data "likely buy time for the FOMC to remain on hold and wait

for additional data," and maintained the firm's call for the Fed

to keep rates unchanged for the rest of the year.

The two-year U.S. Treasury yield, which

typically moves in step with interest rate expectations for the

Fed, tumbled 5.7 basis points to 4.206% after dropping to

4.147%, and was on track for its biggest daily decline since

June 11.

The breakeven rate on five-year U.S. Treasury

Inflation-Protected Securities (TIPS) was last at

2.282% after closing at 2.329% on Monday.

The 10-year TIPS breakeven rate was last at

2.256%, indicating the market sees inflation averaging about

2.3% a year for the next decade.