UPDATE 1-Euro zone bond yields fall, inflation jitters linger

* Euro zone bond yields fall but are set to end week higher

* U.S. 2-year yields set for biggest weekly rise in almost a year

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (updates prices, adds comment)

LONDON, Feb 16 (Reuters) - Borrowing costs across the euro area fell on Friday, although expectations for higher inflation and a step towards tighter monetary policies from major central banks continued to weigh on sentiment across world bond markets.

Short-dated bond yields in Germany, the euro zone's benchmark bond issuer, have risen around 7 basis points this week and were on track for their biggest weekly rise in eight weeks.

In the United States, where data on Wednesday showed consumer prices rose more than expected in January, interest-rate sensitive two-year Treasury yields were set to end the week up 13 bps - the biggest weekly rise in almost a year.

As investors bet the U.S. Federal Reserve could deliver more rate hikes than anticipated this year, bond yields have risen even as equity markets this week appeared to shake off the strong inflation numbers.

"It has been a U.S. story this week, with the CPI data prompting markets to price in more rate hikes from the Fed, which makes sense to us," said Mizuho rates strategist Antoine Bouvet.

"The other interesting development is the weakness in the dollar, which makes investment in the U.S. less attractive as the cost of hedging is higher," he said.

The dollar slipped to a three-year low against a basket of currencies on Friday, headed for its biggest weekly loss in two years.

Expectations for a May rate rise from the Bank of England have also shot up in the past week, while strong economic growth data adds pressure on the European Central Bank to signal a step away from its ultra-loose monetary policy stance.

Still, on Friday there was a slightly firmer tone to bond markets which analysts attributed to some position-squaring ahead of the weekend. U.S. markets are closed on Monday for the President's Day holiday.

Ten-year bond yields across the euro zone were 1-5 bps lower on the day.

Germany's benchmark Bund yield was down 2 bps at 0.74 percent, off recent 2-1/2 year highs.

Two-year German bond yields were steady at minus 0.50 percent, having hit their highest since May 2016 on Thursday at around minus 0.47 percent.

"The trend is still for higher bond yields," said Orlando Green, European fixed income strategist at Credit Agricole.

Southern European bonds in particular outperformed, with Italian 10-year bond yields hitting a one-week low at 2.007 percent.

Italian Prime Minister Paolo Gentiloni said on Friday he did not see a risk of an anti-Europe government taking shape after national elections on March 4.

Elsewhere, there was some focus on Greece with Fitch Ratings due to release its latest review on the indebted southern European state late on Friday.

Fitch rates Greece B- with a positive outlook. In January S&P lifted Greek long-term ratings for the first time in two years.

(Reporting by Kirsten Donovan)