Italy yields fall as Berlusconi seen supporting coalition
* Berlusconi seen retreating from moves to topple coalition
* Italy yields fall back below Spanish ones
* Bunds dip on caution before Fed stimulus decision
By Emelia Sithole-Matarise and Marius Zaharia
LONDON, Sept 17 (Reuters) - Italian bond yields fell back below those of Spain on Tuesday after political sources said former premier Silvio Berlusconi was likely to step back from moves to bring down the government.
Italian 10-year bonds outperformed other euro zone debt in a market where investors were wary of making big shifts on positions before this week's U.S. Federal Reserve meeting at which it is set to start withdrawing its monetary stimulus.
The bonds had lagged Spanish equivalents in recent weeks partly on threats by Berlusconi allies to pull out of the government if he is expelled from the Senate following his tax fraud conviction.
Berlusconi was expected to state his support for the government in a video message on Tuesday but delayed it to Wednesday, according to political sources.
With a Senate committee expected to vote on Wednesday to reject attempts to prevent Berlusconi's ejection from parliament, some political uncertainty also lingered.
"Any clearing up of the skies in domestic politics in Italy will be a big driver here and could support (Italian bonds) even more," said David Schnautz, Commerzbank strategist in Paris. "It's a glimmer of hope but unless we see an official statement it will be treated as something from the rumour mill."
Italian 10-year yields fell 7 basis points on the day to 4.40 percent, dipping back below Spanish equivalents they overtook for the first time in 18 months last week. Spanish
yields were 2 bps lower at 4.41 percent with further falls capped before a Spanish bond sale on Thursday.
Safe-haven Bunds fell after data showed the ZEW German economic sentiment survey for September rose to 49.6 from 42.0 in August, above the 46.0 consensus forecast.
Bund futures shed 43 ticks to 138.07 while cash 10-year yields rose 4 bps to 1.92 percent.
Analysts saw little scope for significant moves in yields from current levels given investors' reluctance to alter their asset allocations before the Fed decision on Wednesday.
Reuters' latest polling of analysts has predicted the Federal Reserve will cut back its $85 billion of monthly asset purchases by $10 billion on Wednesday, less than the $15 billion cut foreseen in an August survey.
Aside from any immediate reaction after the meeting, some traders said global bond yields are likely to keep rising as the move marks the beginning of the end for the ultra-easy monetary policy employed by many central banks since 2008.
Global investors cut their allocations to bonds to the lowest in seven years in September as they positioned for stronger global growth and higher inflation, a monthly fund managers poll from Bank of America Merrill Lynch showed.
"The market is fairly short Bunds, (U.S.) Treasuries and (UK) gilts going into the meeting, but positioning is not excessive," one trader said. "The only thing that will make the market rally will be no tapering at all."
At the other end of the spectrum, junk-rated Portuguese bonds rebounded after a hammering last week over concerns about Lisbon's relationship with its international creditors.
The head of the Eurogroup of finance ministers, Jeroen Dijsselbloem, has rejected Portuguese calls for a softening of the fiscal targets in its bailout deal. A mission of the European Union and the International Monetary Fund is in Lisbon reviewing its progress in meeting the terms of their loans.
Portuguese 10-year yields were 11 bps down at 7.20 percent.