MUMBAI, Jan 13 (Reuters) - Indian government bond yields are likely to fall on Friday, tracking their U.S. peers, as data showed inflation easing in the United States, while lower domestic reading could also lift sentiment.

The fall in yields may, however, remain capped ahead of debt supply through the weekly auction and as traders are likely to lock in profits.

The benchmark 10-year yield is expected to move in a range of 7.25%-7.30%, a trader with a private bank said. The yield ended lower at 7.2859% on Thursday after falling eight basis points in the previous four sessions.

It can now be comfortably said that the worst in terms of inflation is behind, and should boost sentiment, the trader said. "Still, since bonds have been rallying this week based on this event, some profit-booking cannot be ruled out."

Data showed the U.S. consumer price index dipped 0.1% last month after gaining 0.1% in November, and this was the first fall since May 2020, when the economy was reeling from the first wave of COVID-19 infections.

In the 12 months through December, the U.S. CPI accelerated to 6.5%, in line with estimates, still the smallest rise since October 2021 after a 7.1% advance in November.

The 10-year U.S. yield dropped below the crucial 3.50% handle, while the two-year yield was below 4.20%, narrowing the spread that suggested that investors are pricing in fewer rate hikes.

The U.S. Federal Reserve raised interest rates by 425 bps in 2022 and is set to hike by 25 bps in February.

Meanwhile, India's annual retail inflation rose 5.72% in December from 5.88% in the prior month. Analysts in a Reuters poll had predicted a December reading of 5.90%.

The reading remained within the central bank's upper tolerance level of the 2%-6% range for the second consecutive month amid cooling food prices, while industrial output rose at the fastest pace since June, easing concerns for policymakers.

"We fine-tune our FY23 CPI inflation estimate to 6.5% from 6.7% earlier while maintaining FY24 CPI inflation outlook at 5.3%. The RBI is expected to announce 25 bps hike in February, the last rate move in the current cycle," QuantEco Research said. KEY INDICATORS: ** Brent crude futures down 0.6% at $83.60 per barrel, after rising nearly 7% in last four sessions ** 10-year U.S. Treasury yield was at 3.4729% and the two-year note at 4.1677%. ** India to sell federal government bonds worth 300 billion rupees ** RBI to set underwriting fees for bonds worth 300 billion rupees ** RBI to conduct 14-day variable rate reverse repo auction for 1 trillion rupees (Reporting by Dharamraj Dhutia; Editing by Sherry Jacob-Phillips)