Spanish, Italian yields bounce off five-month lows on weak PMIs

* 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 yields bounced off five-month lows on Thursday after surveys showed growth 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 service sector eased sharply, with the purchasing managers' index (PMI) falling to 50.9 from 52.2. It had been expected to nudge up to 52.4 and was below all forecasts in a Reuters poll of 33 economists.

An index measuring new business slumped to 50.2 from September's 27-month high of 51.7.

Anything above the 50 mark indicates growth.

These numbers contrasted with flash Markit/HSBC Purchasing Managers Index (PMI) numbers for China, the world's second biggest economy, which rose to a seven-month high in September.

Italian 10-year yields were up 6 basis points at 4.18 percent, having hit their lowest since early June at 4.085 percent on Wednesday, according to Reuters data.

Equivalent Spanish yields were 3 bps higher at 4.17 percent, having hit their lowest since May at 4.107 percent minutes after the market opened.

The PMI data halted a rally in lower-rated debt on the back of expectations that the Federal Reserve would push back any plans 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 sentiment deteriorated contrary to market expectations. This still shows an economy that's still fragile," said Nick Stamenkovic, a strategist at RIA Capital Markets.


ECB WATCH

The losses were tempered by expectations that the tepid euro zone recovery will foster more monetary easing from the European Central Bank.

At 1.1 percent in September, inflation has fallen way below the 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 ECB extra reasons to ease policy.

Analysts say such speculation is supportive for lower-rated euro zone debt, but some still have doubts the ECB is going to cut rates further or inject more liquidity and say net-net the stronger euro may have a negative impact on those bonds.

"The ECB has said repeatedly that they never use the currency as a medium-term objective," said Gianluca Ziglio, executive fixed income director at Sunrise Brokers. "The strong euro could be problematic for countries like Italy."

Returning to sustainable growth is key for reducing overall indebtedness in peripheral countries.

Bund futures were steady at 140.86, staying within sight of a three-week high of 140.91 hit on Wednesday on expectations of laxer central bank policies. German 10-year yields were flat on the day at 1.77 percent .