* Euro zone PMIs show pace of growth eased
* Periphery yields rise, Bunds stabilise near 3-week highs
* Focus turns back to U.S. PMIs due later in the day
By Emelia Sithole-Matarise and Marius Zaharia
LONDON, Oct 24 (Reuters) - Spanish and Italian bond yieldsbounced off five-month lows on Thursday after surveys showedgrowth in euro zone business activity unexpectedly eased,suggesting the economic recovery may be losing momentum.
The pace of growth in the euro zone's dominant servicesector eased sharply, with the purchasing managers' index (PMI)falling to 50.9 from 52.2. It had been expected to nudge up to52.4 and was below all forecasts in a Reuters poll of 33economists.
An index measuring new business slumped to 50.2 fromSeptember's 27-month high of 51.7.
Anything above the 50 mark indicates growth.
These numbers contrasted with flash Markit/HSBC PurchasingManagers Index (PMI) numbers for China, the world's secondbiggest economy, which rose to a seven-month high in September.
Italian 10-year yields were up 6 basis points at4.18 percent, having hit their lowest since early June at 4.085percent on Wednesday, according to Reuters data.
Equivalent Spanish yields were 3 bps higher at4.17 percent, having hit their lowest since May at 4.107 percentminutes after the market opened.
The PMI data halted a rally in lower-rated debt on the backof expectations that the Federal Reserve would push back anyplans to reduce bond-buying purchases after a two-week U.S.government shutdown caused by political fights over the budget.
"The (PMI) breakdown was mixed and the service sentimentdeteriorated contrary to market expectations. This still showsan economy that's still fragile," said Nick Stamenkovic, astrategist at RIA Capital Markets.
The losses were tempered by expectations that the tepid eurozone recovery will foster more monetary easing from the EuropeanCentral Bank.
At 1.1 percent in September, inflation has fallen way belowthe ECB's close-to-2-percent target and with the euro hitting its highest in two years versus the dollar on Thursday, threatening to choke export growth, that could give the ECBextra reasons to ease policy.
Analysts say such speculation is supportive for lower-ratedeuro zone debt, but some still have doubts the ECB is going tocut rates further or inject more liquidity and say net-net thestronger euro may have a negative impact on those bonds.
"The ECB has said repeatedly that they never use thecurrency as a medium-term objective," said Gianluca Ziglio,executive fixed income director at Sunrise Brokers. "The strongeuro could be problematic for countries like Italy."
Returning to sustainable growth is key for reducing overallindebtedness in peripheral countries.
Bund futures were steady at 140.86, staying withinsight of a three-week high of 140.91 hit on Wednesday onexpectations of laxer central bank policies. German 10-yearyields were flat on the day at 1.77 percent .
- Budget, Tax & Economy