* Bunds rise after sharp sell-off
* Markets wait for Fed QE decision
* Italy to sell up to 6.5 bln euros of bonds
By Kirsten Donovan
LONDON, Sept 13 (Reuters) - German government bonds rose on Thursday with selling the previous day seen overdone but a more positive market tone since a German court backed the euro zone’s rescue fund was expected to keep yields near recent highs.
Activity may be limited before a U.S. Federal Reserve policy announcement at 1630 GMT, with the central bank likely to launch a third round of bond purchases -- dubbed QE3 -- to try to breathe life into the sluggish economy.
“It will be a massive disappointment if they don’t do anything, we’re looking for QE3 and some extension of the zero interest rate policy,” a trader said. “If we don’t get that it’s probably going to be another excuse for Bunds to sell off.”
German Bund futures were up 37 ticks at 139.92, with 10-year yields 3.2 basis points lower at 1.56 percent, having tested the top of their recent trading range.
Markets have been buoyant since Germany’s Constitutional Court cleared the way for the European Central Bank to buy bonds of struggling euro zone countries..
“We’re facing the potential expansion of QE by the Fed and there’s a lot of help being thrown at the various problems out there so it feels OK for now,” said ING rate strategist Padhraic Garvey.
“I can’t imagine it will last for the rest of the year and I think we’ll get another bout of negativity, but for today, and into next week and the week after, it feels OK.”
Spanish government bond yields rose 5 basis points to 5.71 percent, having fallen from over 7 percent in late July. The Italian equivalent was 3 basis points higher at 5.06 percent.
Italy will sell up to 4 billion euros of its July 2015 bond and up to 2.5 billion euros of 2017 and 2026 paper -- with the latter the longest-maturity conventional bond it has tried to sell in more than a year.
“(It‘s) a sign that the Tesoro is confident that the recent market imbalances have reduced somehow,” Annalisa Piazza, market economist at Newedge Strategy, said in a note.
“Demand at today’s BTP auction will be an important test after market dealers’ confidence on a possible solution of the debt crisis seems to have taken the right direction.”
Key for both Spain and Italy in the longer term will be whether they can draw back some of the international investors who have dumped the two countries’ bonds this year.
Although the ECB’s plan is positive for markets, Jack Kelly, a fund manager at Standard Life, which has $247 billion of assets under management, said that alone is probably not enough.
“To get long we really need to see the nature of the ECB buying and their reluctance, or not, and what the scale of the buying is. It may be longer than the market thinks before the Spanish actually request aid,” Kelly said.
“We think peripheral spreads are likely to stabilise around these levels and the volatility may drop but we don’t see much outperformance from here as we’ve already had such a big move.”
Analysts also say the threat of further rating cuts -- Spain is already on the brink of “junk” status -- will deter investors and economic growth will be necessary to entice buyers back.