*

German 2-year yields hit highest since early April

*

ECB signals bar is high for more rate cuts

*

Optimism building for EU-U.S. trade deal

*

PMI surveys, lending and sentiment data point to rosier

outlook

(Updates throughout)

By Amanda Cooper

LONDON, July 25 (Reuters) - German 10-year government

bond yields hit their highest in four months on Friday, as

fading conviction among investors for steeper rate cuts from the

European Central Bank compounded a push out of safe havens on

optimism over U.S.-EU trade talks.

The ECB left interest rates at 2% on Thursday, as expected,

and President Christine Lagarde suggested policymakers were less

concerned than before about an abrupt slowdown in growth and

inflation over the coming year. Bond yields rose sharply in

response.

Meanwhile, optimism is growing that the European Union will

be able to secure an agreement with the United States on trade

at a lower tariff than the 30% threatened by President Donald

Trump if there is no deal by his August 1 deadline.

Government bonds came under pressure, as did gold and

safe-haven currencies like the Japanese yen and Swiss franc.

Two-year German Schatz yields, which rose by

nearly 12 basis points on Thursday in their biggest one-day

increase since mid-May, were up 3.6 bps at 1.947%, their highest

since April 3, the day after Trump's "Liberation Day"

announcement on tariffs.

Benchmark 10-year German yields were up 6 bps to

2.75%, their highest since the end of March, while Italian

yields rose 7 bps to 3.636%, leaving the gap between

the two at 88.2 bps, its widest in a week.

Two sources told Reuters on Thursday that ECB policymakers

were setting the bar high for a September rate cut and would

need to see a significant deterioration in growth and inflation

before backing further easing.

BRIGHTER OUTLOOK

Recent economic data suggests the euro zone is weathering

uncertainty over U.S. tariffs reasonably well.

Euro zone business activity hit an 11-month high in early

July, based on HCOB's preliminary composite euro zone Purchasing

Managers' Index, compiled by S&P Global on Thursday.

"After good PMI numbers and a positive tone from the ECB,

the path towards higher rates is becoming even clearer. If a

trade deal gets signed, we should see rates move up further,

with the 10-year swap rate hitting at least 2.8%," ING rates

strategist Michiel Tukker said.

The 10-year swap rate, an indicator of

long-term borrowing costs, is hovering around 2.7%, its highest

since March, having risen by nearly 20 bps in the last month.

Tukker said a move towards 3% would likely be slower and

would depend on growth remaining resilient.

Money markets show traders are undecided about another ECB

rate cut this year, attaching about a 30% chance of a drop below

2% by the end of December.

Reflecting some of that greater confidence in the outlook

was a modest improvement in German business morale in July. A

survey on Friday from the Ifo institute showed its business

climate index rose to 88.6 this month - the highest in 13 months

- from 88.4 in June, slightly below a Reuters forecast for 89.0.

A separate report from the ECB showed bank lending in the

euro zone grew at the fastest pace in two years last month,

extending a gradual recovery fuelled by lower borrowing costs

and a stabilisation in the economy.

(Reporting by Amanda Cooper; Editing by Mark Potter and Emelia

Sithole-Matarise)