* Spanish, Italian yields extend falls
* Fitch upgrades Spain outlook to stable from negative
* ECB outlook offsets unease over Italy's political tensions
* German, French, Dutch and Austrian bonds also firm
LONDON, Nov 4 (Reuters) - Spain's bonds outpaced other euro zone debt on Monday after Fitch upgraded its credit ratings outlook, in a market underpinned by bets the European Central Bank could signal further monetary easing this week.
Core and lower-rated euro zone bonds rallied in the past week after slowing inflation firmed up market bets the ECB will ease policy further in coming months.
Surveys showing factory activity in the region accelerated as expected in October did little to change investors' views on the ECB, as shrinking manufacturing in France hampered a robust recovery.
Fitch revised on Friday Spain's credit ratings outlook to stable from negative, citing progress in cutting the deficit and a sooner-than-expected return to growth.
The ECB outlook offset concerns about political tensions in Italy before a Senate vote on whether to expel former premier Silvio Berlusconi from parliament after a tax fraud conviction.
Spanish two-year yields fell 6 basis points to 1.04 percent with 10-year yields 4 bps down at 3.98 percent . Italian two- and 10-year yields were 4 bps and 1 bps lower at 1.37 percent and 4.11 percent respectively.
"The Fitch release at the end of the week on Spain's outlook was clearly welcomed by the market so in the meantime we see Spain outperforming Italy," said Matteo Regesta, a strategist at Citi.
"The idea that ECB is going to come back to the market with some action of sorts is clearly supportive of the periphery as it has been in the past."
It is unclear going into Thursday's meeting whether, if it moves, the ECB moves, would opt to cut rates or prefer to give banks a fresh injection of cheap long-term loans.
Some banks expect it to cut its main refinancing rate to 0.25 percent from 0.50 percent, but many in the market see it holding fire until December when it has new economic forecasts.
Money market distortions created by excess liquidity in the euro system, which is now at two-year lows of 175 billion euros as banks repay the ECB's 2011 and 2012 three-year loans (LTROs), make it difficult to assess how much easing, if any, is priced in for the December meeting.
But it is clear the market is not expecting the bank to cut the rate it charges banks for depositing cash with it overnight into negative territory. The overnight Eonia rate for December, which trades just above the deposit rate, traded around 0.12 percent. It would be near or below zero were the market discounting such a move.
In core markets, the German Bund futures rose 5 ticks to 141.90, having hit two-month highs at 142.32 last Thursday. Cash 10-year Bund yields fell 1 bps to 1.68 percent and Dutch, French and Austrian yields also dipped.
Commerzbank strategists urged caution over the ECB meeting.
"We still see the risk that the ECB may struggle to live up to the increasing expectations for additional stimulus measures as the ECB may not share the sense of urgency to act," they said.
"Unintended side effects from negative interest rates or LTROs may be too high a hurdle. A dovish wording from Draghi is ensured but no action this week is still likely to see rates markets souring."