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UPDATE 1-German yields hit one-month highs as 'soft Brexit' hopes build

* German 10-year yields up to 0.26 pct, tracking Gilts

Hopes grow that 'no-deal Brexit' will be avoided

* Report suggests improved Sino-U.S. trade talks

* Italian bonds revel in post-syndication high

* Euro zone periphery govt bond yields (Updates prices)

By Abhinav Ramnarayan

LONDON, Jan 18 (Reuters) - German government bond yields rose to a one-month high on Friday as hopes grew that Britain would avoid a messy divorce from the European Union and perhaps hold a second referendum, raising the prospect of no Brexit at all.

Hopes of a more constructive stance in Sino-U.S. trade talks fuelled by a report that U.S. Treasury Secretary Steven Mnuchin discussed lifting tariffs imposed on Chinese imports also helped erode some of the safety bid for German Bunds.

While analysts warned that it was too early to call a "soft Brexit", the chances seem higher after this week's events, when Prime Minister Theresa May lost a vote on her Brexit deal by a historic margin but survived a no-confidence vote.

Sterling is set for its best weekly run against the euro in more than a year as a result, and German Bunds -- feeling the effect of worries over a no-deal Brexit -- lost some of their safety appeal.

"We have more voices say that a second referendum could be an option, and though I believe it's more hopes than reality, it is a factor moving yields higher," said DZ Bank analyst Pascal Segesser.

German 10-year yields rose to a near one-month high of 0.263 percent, up 2 basis points on the day and 9 bps this week; its first weekly rise since early November.

Most of the other higher-rated euro zone bond yields were also 1 to 2 bps higher on the day.

This as 10-year Gilt yields hit a five-week high of 1.36 percent, up 3 bps on the day, before settling around 1.35 percent.

Elsewhere, a Wall Street Journal report said the U.S. Treasury secretary discussed lifting some or all tariffs imposed on Chinese imports and suggested offering a tariff rollback during trade discussions scheduled for Jan. 30.

The Treasury later denied the report, but Segesser of DZ Bank said it still raised hopes of a breakthrough in Sino-U.S. talks.

Ten-year U.S. Treasury yields hit a near three-week high of 2.775 percent.

Meanwhile, Italian bond markets continued their strong performance of the week following Tuesday's 10 billion-euro bond sale, with five-year and 10-year yields down 3-4 bps.

The closely watched Italy/German 10-year bond yield spread was at its tightest since the start of the year at 247 bps. (Reporting by Abhinav Ramnarayan, editing by Larry King)