* Spanish yields fall, Fed outlook underpins riskier assets
* Bunds hit new 2-month high in thin volumes
* Italian debt stable as market absorbs supply
By Emelia Sithole-Matarise and Marius Zaharia
LONDON, Oct 28 (Reuters) - Spanish yields fell on Monday as expectations the U.S. Federal Reserve will keep its monetary stimulus at current levels at a policy meeting this week supported demand for riskier assets.
Spanish bonds outpaced Italian paper, which was hobbled by the prospect of up to 9 billion euros of debt sales this week.
Spain clawed back ground lost last week after below-forecast German sentiment and euro zone business sector surveys raised concern about the bloc’s recovery.
Last week’s modest rise in yields lured back investors encouraged by the prospect that the Fed will not begin trimming its bond purchases until early next year to lessen the economic impact of a two-week government shutdown, analysts said.
“Investors seem to be scaling back into peripherals because the market is confident that the Fed will remain with its foot on the stimulus pedal,” said Felix Herrmann, market strategist at DZ Bank in Frankfurt.
Spanish 10-year yields fell 6 basis points to 4.09 percent. Bank of Spain forecasts that the country escaped a two-year recession in the third quarter thanks to strong exports were also supporting the bonds, traders said.
“The recovery is finding some footing there and it is expected to continue next year. This is also a positive driver for Spanish bonds,” Commerzbank rate strategist David Schnautz said.
Equivalent Italian yields edged lower to 4.19 percent as the market absorbed a sale of 3 billion euros of zero-coupon and inflation-linked debt which met healthy demand.
Rome plans to sell on Wednesday a further 6 billion euros of conventional bonds. Many in the market expect the sale to go well, supported by 24 billion euros in redemption flows.
Investors largely shrugged off political tensions in Italy, buoyed by expectations central banks, including the European Central Bank, would maintain ultra-easy monetary policies.
A looming Senate vote over whether to expel former prime minister Silvio Berlusconi from parliament and rifts shaking his centre-right party are exacerbating tensions for the fragile left-right coalition government.
German Bund futures rose three ticks to 141.09, having hit a two-month peak of 141.23 earlier in the session. German 10-year yields were steady at 1.75 percent.
A storm in London has hit trading volumes across financial markets. Just over 400,000 lots of Bund future contracts exchanged hands on Monday, compared with a daily average of above 700,000 in 2013.