* Bunds fall with Treasuries on rising bets of a U.S. debtdeal
* German yields could spike above 2 percent if deal reached
* Spain, Italy yields extend recent falls
By Emelia Sithole-Matarise
LONDON, Oct 15 (Reuters) - German 10-year yields rose totheir highest in three weeks on Tuesday as expectations thatU.S. lawmakers will find a deal to avert a potential debtdefault pulled investors out of top-rated government bonds infavour of riskier assets.
The move tracked a rise in U.S. Treasury yields in Asiaafter U.S. Senate Majority leader Harry Reid, a Democrat, andhis Republican counterpart, Mich McConnell, ended a day of talkson Monday, with Reid saying they had made "tremendous progress".
The plan under discussion would promptly end a partialgovernment shutdown about to enter its third week and raise thedebt ceiling by enough to cover the country's borrowing needs atleast through mid-February, according to a source familiar withnegotiations.
The Bund future, sought by investors as asafe-haven in times of market stress, was last down 39 ticks at139.36. German 10-year yields were 3.5 basispoints up at 1.90 percent, their highest since Sept. 23 withbenchmark U.S. yields were up by a similar amount at2.72 percent.
Other higher-rated euro zone bond yields, notably Dutch,Austrian and French, were also higher on the day.
"There's an opening in negotiations for politicans to reachan agreement so we've seen a rise in Treasury and Bund yieldsand we also have an improvement in sentiment in (euro zone)periphery (debt) and if there's an improvement in European datacore bond yields should go higher," said Alessandro Giansanti, astrategist at ING in Amsterdam.
He said Bund yields could spike to this year's peak of 2.059percent hit in early September when markets were bracing for theU.S. Federal Reserve to start trimming its monetary stimulus.That would depend on data, including German ZEW and U.S.investor sentiment surveys due later in the day, showing furtherimprovement.
Commerzbank analysts, however, were cautious about theimpact of the U.S. debt wrangle on the sentiment surveys.
"Granted, a collapse seems remote as both the analystssurveyed by ZEW and the manufacturing executives surveyed by theNew York Fed were probably still hopeful when filling out theirsurvey last week," they said.
"Given the complacent consensus - unchanged ZEW, slightlyhigher New York Fed - and the structural damage inflicted by theU.S. squabble, however, downside risks prevail in today'snumbers."
Italian and Spanish yields slipped further, extending lastweek's falls on an upbeat tone in riskier assets and afterrecent solid debt sales in Rome and Madrid. Italian 10-yearyields were 2 bps down at 4.24 percent with theSpanish equivalent 1.4 bps lower at 4.26 percent.