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

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)