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TREASURIES-U.S. bonds flat as government shutdown looms

* Treasuries on track for first monthly gain since April

* Worries over Italian government stoke safe-haven bids

* Chicago PMI highest since May, Dallas Fed index jumps

By Richard Leong

NEW YORK, Sept 30 (Reuters) - U.S. Treasuries prices were little changed on Monday after they rose earlier and sent yields to their lowest levels in seven weeks on safehaven bids due to worries about a partial government shutdown.

If a budget deal does not materialize later Monday, the government will stop funding nonessential services at midnight, which would cause furloughs of some government employees and, analysts say, act as a drag on the U.S. economy.

This latest chapter of a stalemate over the federal budget, together with the Federal Reserve's decision to refrain from shrinking its monthly bond purchases earlier this month, have stabilized the Treasuries market following a summer selloff.

U.S. government debt was on track to post its first monthly gain since April and to eke out its first quarterly rise since a year ago, according to Bank of America Merrill Lynch.

"The best way to say what the market is doing right now is that it's pricing in a partial government shutdown," said John Herrmann, director of interest rates strategy at Mitsubishi UFJ Securities in New York.

Investors, while monitoring for any breakthroughs in the budget talks in Washington, have also been defensive after Italy's former prime minister Silvio Berlusconi ordered five center-right ministers to leave the government, threatening the governing coalition.

Analysts warned a political collapse in euro zone's third-largest economy would hamper efforts to fix its finances and hurt investor confidence in the euro zone block, which has shown signs of recovery recently.

But on Monday as many as 20 senators from Berlusconi's party were ready to form a breakaway group unless the former premier backs down on his hard line to bring down Italy's government.

This development curbed earlier safety bids for Treasuries, German Bunds and other low-risk assets.

Bond demand was also held in check following a report from the Institute for Supply Management-Chicago that showed business activity in the upper Midwest region grew at its fastest pace since May. The Dallas Fed said its gauge on Texas manufacturing strengthened in September to its strongest level since early 2011.

Benchmark 10-year Treasury notes were little changed in price at 98-28/32 to yield 2.628 percent after they had traded up as much as 11/32 with a yield of 2.59 percent.

"We are not in a complete risk-off world. It's a temporary move to safety," Herrmann said.

Some traders still anticipated a possible last-minute deal in Washington to avert a government shutdown, which would cause an unwind of some safe haven bond holdings.

"It's a very fluid situation," said Scott Graham, head of U.S. government bond trading with BMO Capital Markets in Chicago. "The market is trading in a tight range. People are getting a bit tired of the situation."

The 10-year yield was on course to fall 16 basis points in September for its first decline in five months, but it was still set to rise for a fourth consecutive quarter.

Treasuries fared better than their German counterparts as the yield premium on U.S. 10-year debt over 10-year Bunds shrank to 0.83 percent from 0.85 percent on Friday.

While a government shutdown has spurred bids for its debt, a protracted shutdown, in addition to a looming fight over raising the $16.7 trillion debt ceiling, could damage the safe-haven status of Treasuries and the U.S. dollar.

The cost to insure against a U.S. default rose to its highest level since May. Investors would have to pay about 35,500 euros annually to insure 10 million euros worth of Treasuries against a default in five years, up from 31,000 euros on Friday's close, according to data from Markit.

While as many as 1 million federal workers could face payless paydays if lawmakers won't reach a deal to fund the government, some branches of government including the Federal Reserve will stay open.

The U.S. central bank bought $1.47 billion in Treasuries that mature in February 2038 to August 2043, the last of its Treasuries purchases in September for its third round of quantitative easing, known as QE3.