By Emelia Sithole-Matarise
LONDON, Oct 30 (Reuters) - German Bund futures rose to two-month highs on Wednesday as investors counted on the U.S. Federal Reserve keeping monetary policy unchanged when it winds up its meeting later in the day.
Financial markets have rallied over the past week on bets the Fed will probably maintain its current pace of bond-buying in a bid to prop up an economy damaged by this month's government shutdown in Washington.
Mixed U.S. economic data so far has persuaded many in the market that the Fed will keep to its $85 billion a month bond purchases until at least early next year.
"It looks unlikely that the Fed will back off the tapering plan completely," said Rainer Guntermann, a strategist at Commerzbank, "But any hint that they are pedaling back and that the fiscal uncertainty could have a much more lasting impact on economic activity would be a dovish statement.
"A lot of this postponed tapering should be priced in already ... so we wouldn't be surprised to see at some point and possibly as well as tonight as we get into the FOMC a bit of profit-taking."
The Bund future was last 22 ticks up on the day at 141.49, its highest since August, while German 10-year yields were 1.6 basis points down at 1.72 percent.
Given the positive market backdrop, an upcoming German sale of up to 4 billion euros of 10-year Bunds should meet solid demand.
Euro zone bonds across the credit spectrum have also been supported by market speculation that the European Central Bank will ease monetary policy further to support a fragile recovery threatened by a strong euro and curb a rise in money market rates as excess liquidity in the euro system dwindles.
Spanish yields were last 2 basis points lower at 4.03 percent with Italian equivalents 3 bps down at 4.12 percent before a sale of up to 6 billion euros of 5- and 10-year bonds in Rome that was seen faring well.
Spain has been outperforming Italy in recent days with investors encouraged by data showing the Iberian country escaped a two-year recession in the third quarter thanks to strong exports.
Barclays strategists say Spanish yields could trade 20 to 30 bps below Italian equivalents in coming days, saying Spain's economic prospects in coming months looked more positive, with Madrid well ahead of Rome with structural reforms.
But they said this outperformance was likely to peter out in coming months as Italy still benefits from a more liquid debt market which made it the portfolio choice for foreign investors.