* Italian and Spanish govt bonds rally in thin trade * China data helps soothe concerns, U.S. ISM in focus * RBS still see to scope for fresh flight-to-quality By William James LONDON, April 2 (Reuters) - Italian and Spanish bonds rallied as global growth fears cooled, with investors seeking further confirmation of a more benign outlook from U.S. manufacturing data later on Monday. Yields on riskier euro zone bonds fell, beginning the second quarter on a positive note after surprisingly strong Chinese purchasing management data soothed some concerns about the world's second largest economy. "It comes from the official Chinese PMI which was better than expected," a trader said, adding that trading activity was subdued and, as a result, price moves were exaggerated. Analysts said the release of several major U.S. economic indicators in the coming days, starting with Institute of Supply Management's manufacturing survey, would be crucial to how bonds trade in the coming weeks. "The key for this week seems to be the data releases from the U.S. - that will really set the tone," said Achilleas Georgolopoulos, strategist at Lloyds Bank in London. Ten-year Italian yields were down 4 basis points at 5.08 percent, while the equivalent Spanish yield fell 4.5 bps to 5.32 percent. Both countries' bonds were off their best levels and low-risk German Bunds pared losses as short-term investors sought to reduce exposure to thin, volatile markets. "It's the intraday trading which is driving this...it really is more cutting of longs in risky assets and a little bit of short-covering in so-called safe-haven assets," said Marc Ostwald, strategist at Monument Securities in London. German Bund futures, considered the currency bloc's safe-haven asset, were 44 ticks lower versus Friday's 1715 GMT settlement of 138.05, having earlier sunk as low as 137.72. While lower against Friday's settlement close, Bunds were up compared with the official close at 138.02 after selling off sharply in after-hours trade as investors made final portfolio adjustments before the end of the quarter. DATA FOCUS Purchasing management data from the euro zone confirmed earlier estimates of a grim outlook for the currency bloc, which is struggling to generate the growth needed to tackle the debt problems dogging its weaker peripheral economies. By contrast, investors will be keen to see whether recent positive momentum in the U.S. economy can be sustained when manufacturing data is released at 1400 GMT. Reuters consensus forecasts were for a reading the index to rise to 53 from 52.4 in February. "We will have economic indicators from the U.S.. Should they prove as robust as recent ones were, we could have further re-widening in T-note/Bund spreads," said Patrick Jacq, strategist at BNP Paribas in Paris. Highlighting the elevated caution in the euro zone relative to optimism over the U.S. economy, 10-year Treasury yields were at a 13-1/2 month high of 39 bps above those on German Bunds, matching last week's extremes. Despite the intra-day risk-on move, Royal Bank of Scotland strategists saw scope for German bonds to rally over the medium term, arguing that a 10-year yield of 1.67 percent represented fair value, according to their model. The Bund yield was last at 1.83 percent, up 4 bps compared to Friday's settlement. Citing the fading effect of central bank cash injections, which pushed peripheral debt yields lower in the first quarter, the bank also recommended investors take short positions in five-year Spanish debt. Five-year Spanish bonds yield 4.15 percent, with RBS setting an initial target of 4.5 percent, and then 5 percent.

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