* Bunds fall with Treasuries on rising bets of a U.S. debt deal
* German yields could spike above 2 percent if deal reached
* Spain, Italy yields extend recent falls
By Emelia Sithole-Matarise
LONDON, Oct 15 German 10-year yields rose to their highest in three weeks on Tuesday as expectations that U.S. lawmakers will find a deal to avert a potential debt default pulled investors out of top-rated government bonds in favour of riskier assets.
The move tracked a rise in U.S. Treasury yields in Asia after U.S. Senate Majority leader Harry Reid, a Democrat, and his Republican counterpart, Mich McConnell, ended a day of talks on Monday, with Reid saying they had made "tremendous progress".
The plan under discussion would promptly end a partial government shutdown about to enter its third week and raise the debt ceiling by enough to cover the country's borrowing needs at least through mid-February, according to a source familiar with negotiations.
The Bund future, sought by investors as a safe-haven in times of market stress, was last down 39 ticks at 139.36. German 10-year yields were 3.5 basis points up at 1.90 percent, their highest since Sept. 23 with benchmark U.S. yields were up by a similar amount at 2.72 percent.
Other higher-rated euro zone bond yields, notably Dutch, Austrian and French, were also higher on the day.
"There's an opening in negotiations for politicans to reach an agreement so we've seen a rise in Treasury and Bund yields and we also have an improvement in sentiment in (euro zone) periphery (debt) and if there's an improvement in European data core bond yields should go higher," said Alessandro Giansanti, a strategist at ING in Amsterdam.
He said Bund yields could spike to this year's peak of 2.059 percent hit in early September when markets were bracing for the U.S. Federal Reserve to start trimming its monetary stimulus. That would depend on data, including German ZEW and U.S. investor sentiment surveys due later in the day, showing further improvement.
Commerzbank analysts, however, were cautious about the impact of the U.S. debt wrangle on the sentiment surveys.
"Granted, a collapse seems remote as both the analysts surveyed by ZEW and the manufacturing executives surveyed by the New York Fed were probably still hopeful when filling out their survey last week," they said.
"Given the complacent consensus - unchanged ZEW, slightly higher New York Fed - and the structural damage inflicted by the U.S. squabble, however, downside risks prevail in today's numbers."
Italian and Spanish yields slipped further, extending last week's falls on an upbeat tone in riskier assets and after recent solid debt sales in Rome and Madrid. Italian 10-year yields were 2 bps down at 4.24 percent with the Spanish equivalent 1.4 bps lower at 4.26 percent.