Italian bonds outperform, but moves limited before Fed
* Italian bonds outperform before Berlusconi vote
* German bonds rise as investors bet on "dovish" Fed
* Fed expected to announce $10-15 bln taper
By Marius Zaharia and Ana Nicolaci da Costa
LONDON, Sept 18 (Reuters) - Italian bonds outperformed other euro zone debt on Wednesday as former premier Silvio Berlusconi was expected to steer his political allies away from moves to bring down the government.
Market moves were limited, however, as investors were wary of making big shifts in asset allocations before the end of a two-day Federal Reserve meeting, where U.S. central bankers are expected to start withdrawing monetary stimulus.
Berlusconi was expected to release a video message later on Wednesday, in which political sources said he would step back from weeks of threats to sink the right-left coalition of Prime Minister Enrico Letta.
The threats were related to a Senate vote later in the day on whether to expel him following his tax fraud conviction.
Ten-year Italian yields were 2 basis points lower on the day at 4.39 percent. Most other euro zone yields were higher as investors saw the Fed meeting as the beginning of the end for the ultra-loose monetary policy employed by the world's major central banks.
"Investors are hopeful that he will try to be more diplomatic and the coalition will remain in place and that clearly would be good news for Italian government bonds," Nick Stamenkovic, bond strategist at RIA Capital Markets said.
But he added: "You never know with Mr. Berlusconi, he can surprise the markets in either direction."
Italian yields fell back below those of Spain on Tuesday, having overtaken them for the first time in 18 months last week.
Spain is due to sell 2-3 billion euros of five- and 15-year bonds on Thursday. The auction is expected to go smoothly, although some uncertainty remains about what impact could the Fed meeting have on demand for the auction.
"Italy's overperformance of Spain is very relevant and there is room for more of that. We have supply coming out of Spain tomorrow and that can have an impact as well," ING rate strategist Alessandro Giansanti said.
Latest Reuters polling of economists shows a consensus for the Fed tapering by a modest $10 billion compared to $15 billion in August, although there were a variety of views in the market for how high a figure was priced in.
One bonds trader said anything above $20-$25 billion would trigger a sell-off but there are also expectations it may deliberately steer the market with language pushing back the prospect of a rise in interest rates far into the future.
"People have been waiting for the Fed for a long time and will wait to see what they say before they really dive in," the trader said.
"You just feel people are thinking that (Fed Chairman Ben Bernanke) might be a bit dovish so maybe that's a risk."
Bund futures were 27 ticks lower at 137.80, while ten-year German yields were 2.4 bps up at 1.945 percent, off 1-1/2 year high of 2.059 percent hit earlier this month.
"The Fed will ... (signal) that they are slowly but surely aiming towards normalization of monetary policy. And against that backdrop, I find it hard to see Bund yields holding below 2 percent near-term," RIA's Stamenkovic added.
Two-year German yields were up 1.6 bps at 0.21 percent after a Schatz auction which saw less demand than a previous sale.
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