* Yields steady after Monday's sharp falls
* Fed and BOJ optimistic on economy
* Italy proposes bank rescue plan (Updates prices)
By John Geddie
LONDON, Dec 20 (Reuters) - Optimistic signals from two of the world's most influential central banks and a rescue plan for Italy's ailing lenders halted sharp falls in euro zone government bond yields on Tuesday.
Nerves around a faltering private sector recapitalisation for Italian lender Monte dei Paschi and apparently politically motivated killings in Germany and Turkey pushed yields on Europe's safe haven benchmark Bund to two-week lows on Monday.
But comments by Federal Reserve chair Janet Yellen on the strength of the U.S. jobs market, followed by a more upbeat view of the economy from the Bank of Japan, appeared to kick the rally into reverse on Tuesday.
The Italian government's plan to borrow 20 billion euros to underwrite banks like Monte dei Paschi, and comments from the Bank of Italy that national and European institutions are committed to helping the sector, also soothed jittery markets.
German 10-year bond yields rose 1.5 basis points to 0.28 percent, steadying after a 10 basis point fall on Monday, while most other euro zone equivalents were broadly 1-2 bps higher.
"The market is changing focus nowadays quite quickly," DZ Bank strategist Daniel Lenz said. "Yesterday we had a lot of focus on Italy and now it is more the economic assessment that is driving things."
While Yellen didn't mention monetary policy in her speech to university students on Monday, she said graduates were entering the strongest jobs market in nearly a decade.
Some investors had been wary Yellen might pour cold water on market expectations for a faster pace of rate hikes next year, so her upbeat assessment of the economy brought relief.
Yellen's remarks were followed by a positive assessment of Japan's economic prospects from the BOJ. While the central bank kept monetary policy on hold on Tuesday, its comments reinforced market expectations that its future policy direction could be an increase - not a cut - in interest rates.
In the euro zone, a government bailout of Monte dei Paschi could come as early as this week, if the bank fails to pull off its own privately funded rescue plan.
While that appears to have calmed investor nerves for now, it could be tough for the week-old administration of Prime Minister Paolo Gentiloni, given that investors are required to bear losses under EU bailout rules.
Italy's bonds settled after some early losses, and the yield came down from a high of 1.89 percent in early trades to reach 1.85 percent by 1635 GMT, up 1.6 bps on the day.
For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (Editing by Mark Trevelyan)