* Spanish yields fall, Fed outlook underpins riskier assets
* Bund rally pauses as equities rally
* Bunds still within sight of 2-month highs hit last week
By Emelia Sithole-Matarise
LONDON, Oct 28 (Reuters) - Spanish yields fell on Monday asexpectations the Federal Reserve will keep its monetary stimulusat current levels at a policy meeting this week supported demandfor riskier assets.
Spanish bonds outpaced Italian paper, which were hobbled bythe prospect of up to 9 billion euros of debt sales this week.
Spain clawed back ground lost last week after below-forecastGerman sentiment and euro zone business sector surveys raisedconcern about the bloc's recovery.
Last week's modest rise in yields lured back investorsencouraged by the prospect that the Fed will not begin trimmingits bond purchases until early next year to lessen the economicimpact of a two-week government shutdown, analysts said.
U.S. economic reports this week, delayed by the shutdown,are expected to support the view that the Fed needs to maintainstimulus to support a recovery that has slowed in recent weeks.
"Investors seem to be scaling back into peripherals becausethe market is confident that the Fed will remain with its footon the stimulus pedal," said Felix Herrmann, market strategistat DZ Bank in Frankfurt.
Spanish 10-year yields were last 4 basispoints down on the day at 4.11 percent while equivalent Italianyields were steady at 4.21 percent as the marketabsorbed a sale of 3 billion euros of zero-coupon andinflation-linked debt which met healthy demand.
Rome plans to sell on Wednesday a further 6 billion euros ofconventional bonds. Many in the market expect the sale to gowell, supported by 24 billion euros in redemption flows.
Investors largely shrugged off political tensions in Italy,buoyed by expectations central banks, including the EuropeanCentral Bank, would maintain ultra-easy monetary policies.
A looming Senate vote over whether to expel former primeminister Silvio Berlusconi from parliament and rifts shaking hiscentre-right party are exacerbating tensions for the fragileleft-right coalition government.
German Bund futures rose four ticks to 141.06,having hit a two-month peak of 141.22 last week. German 10-yearyields were steady at 1.75 percent.
Some market participants said the yields could move lower ifU.S. data this week undershoots expectations.
"Any strong data this week will be shrugged off by themarket and any data that's weak will reinforce the market viewthat the Fed is not going to taper until next year," said NickStamenkovic, a strategist at RIA Capital Markets.
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