* 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 as expectations the Federal Reserve will keep its monetary stimulus at current levels at a policy meeting this week supported demand for riskier assets.
Spanish bonds outpaced Italian paper, which were hobbled by the prospect of up to 9 billion euros of debt sales this week.
Spain clawed back ground lost last week after below-forecast German sentiment and euro zone business sector surveys raised concern about the bloc's recovery.
Last week's modest rise in yields lured back investors encouraged by the prospect that the Fed will not begin trimming its bond purchases until early next year to lessen the economic impact 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 maintain stimulus to support a recovery that has slowed in recent weeks.
"Investors seem to be scaling back into peripherals because the market is confident that the Fed will remain with its foot on the stimulus pedal," said Felix Herrmann, market strategist at DZ Bank in Frankfurt.
Spanish 10-year yields were last 4 basis points down on the day at 4.11 percent while equivalent Italian yields were steady at 4.21 percent as the market absorbed a sale of 3 billion euros of zero-coupon and inflation-linked debt which met healthy demand.
Rome plans to sell on Wednesday a further 6 billion euros of conventional bonds. Many in the market expect the sale to go well, supported by 24 billion euros in redemption flows.
Investors largely shrugged off political tensions in Italy, buoyed by expectations central banks, including the European Central Bank, would maintain ultra-easy monetary policies.
A looming Senate vote over whether to expel former prime minister Silvio Berlusconi from parliament and rifts shaking his centre-right party are exacerbating tensions for the fragile left-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-year yields were steady at 1.75 percent.
Some market participants said the yields could move lower if U.S. data this week undershoots expectations.
"Any strong data this week will be shrugged off by the market and any data that's weak will reinforce the market view that the Fed is not going to taper until next year," said Nick Stamenkovic, a strategist at RIA Capital Markets.