* German Bunds rally after U.S. GDP data misses forecasts
* New Italian government seen appointed on Saturday-sources
* Italian yield rise attracts some buyers; stabilises on day
By Emelia Sithole-Matarise and Marius Zaharia
LONDON, April 26 Demand for low-risk government bonds lifted German Bunds on Friday after data showed the U.S. economy grew at a slower-than-forecast pace in the first quarter.
The U.S. figures fueled bets the Federal Reserve might consider more measures to bolster the economy at its policy meeting next week, at the same time as the European Central Bank is expected to cut official interest rates.
German Bunds are seen holding onto their gains going into next week, with investors keeping a wary eye on Italy's efforts to form a new government and end a two-month political impasse in the euro zone's third largest economy.
"The latest German data we have seen puts the likelihood slightly above 50 percent that the ECB could lower its target rate although it's questionable how that would help. The potential for market disappointment is not that big," said Norbert Wuthe, a strategist at Bayerische Landesbank in Munich.
Bund futures settled 34 ticks up on the day at 146.54, having risen as high as 146.63 after the U.S. data, near their all-time highs of 146.89 reached in June 2012.
German 10-year yields fell 3 basis points to 1.21 percent with market participants saying they could retest record lows of 1.126 percent set in July if the ECB goes ahead and cut rates as expected.
ITALY PROGRESS EYED
Bunds were also supported earlier by weakness in higher-yielding Italian bonds on investor wariness that talks to form a government could be derailed by major differences between the country's centre-left and centre-right political groupings.
Traders played down three sessions of losses this week in Italian and Spanish bonds as profit-taking after a strong rally that pushed 10-year yields to 2-1/2 year lows on Tuesday. They said the longer-term positive trend for Italian and Spanish bonds was intact.
Yields reversed their early rise to end steady to slightly lower on the day after political sources told Reuters Prime Minister-designate Enrico Letta could announce a new government on Saturday and spell out its programme early next week.
Any progress on this and an environment dominated by abundant central bank liquidity is expected to whet investor appetite for the country's 6 billion euro bond auction on Monday.
Italian 10-year yields were last flat at 4.06 percent, having hit a session high of 4.14 percent earlier and 2-1/2 year lows of 3.89 percent on Tuesday.
Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers in London, said the market was still largely expecting Italy to form a government and he expected yields to fall back to 3.90 percent once it does.
Afterwards, yields would be driven by how swiftly it moves to tackle issues such as a complicated electoral law and wider growth boosting reforms.
"There will be a government. How long is it going to last that's a different question. Sooner or later (differences) are going to arise again. The main thing is how much they can do before that," Ziglio said.