* Mexico, U.S. reach agreement on trade
* S&P 500, Nasdaq indexes hit record highs
* German business sentiment brightens (Updates to U.S. stock market close)
By Trevor Hunnicutt
NEW YORK, Aug 27 (Reuters) - An index of major world stock markets rose to its highest level in more than five months on Monday after the United States and Mexico struck an agreement that lowers trade tensions.
MSCI's gauge of stocks in 47 countries across the globe gained 0.98 percent, helped by gains in developed markets from the United States to Europe and Asia. The broad index was at its highest level since March.
The benchmark S&P 500 and the Nasdaq indexes hit records, bond prices fell and copper prices rose as the United States and Mexico agreed to overhaul the North American Free Trade Agreement (NAFTA), putting pressure on Canada to agree to the new terms on auto trade and other issues to remain part of the three-nation pact. Agreement could ease concerns about an escalation in global trade tensions.
Major currencies gained against the U.S. dollar, which has been a safe haven from months of trade tensions.
"The (NAFTA) talks add to the sense that while the U.S. is still bogged down in its trade conflict with China, it is perhaps more willing to compromise elsewhere such as with Mexico and the EU," said Ulrich Leuchtmann, head of FX and emerging market research at Commerzbank in Frankfurt.
"It's decreasing the risk of a global trade war."
The Dow Jones Industrial Average rose 259.29 points, or 1.01 percent, to 26,049.64, the S&P 500 gained 22.05 points, or 0.77 percent, to 2,896.74 and the Nasdaq Composite added 71.92 points, or 0.91 percent, to 8,017.90.
The S&P and Nasdaq indexes both hit record highs, continuing a run that followed Fed chief Jerome Powell's speech at the Jackson Hole symposium on Friday. Powell affirmed that the U.S. central bank was sticking with its strategy of gradual rate hikes. The gains on Friday cemented the S&P's longest-running bull market.
A stronger-than-expected German business sentiment survey added to the upbeat mood in Europe. The pan-European FTSEurofirst 300 index rose 0.52 percent while British markets were closed for a public holiday.
"We have low volumes today, but the biggest risks the market were discounting were trade wars, so any reduction in trade war risk such as NAFTA talks or even Trump trying to find bilateral deals with everyone, has pushed U.S. shares to new records and will support markets," said Angelo Meda, head of equities and a portfolio manager at Banor SIM in Italy.
"The global economy is on track, there's less trade war risk, the only cloud on the horizon is Italy," added Meda, referring to upcoming budget talks.
Benchmark 10-year U.S. Treasury notes last fell 6/32 in price to yield 2.8477 percent, from 2.826 percent late on Friday.
In currency markets, the dollar stepped back after weeks of gains in the face of aggressive Fed rate hikes and trade disputes. The dollar index fell 0.44 percent.
China's yuan hit a near-4-week high to the dollar after the central bank revived a "counter-cyclical factor" in its daily fixing to support the currency, giving hopes that Beijing might halt a record 10-week slide that rattled global markets.
The yuan traded offshore rose to a high of 6.7818, its strongest since July 31, but later pared some gains.
Commodity markets showed signs of optimism about global economic growth prospects. Copper, a major industrial metal, rose 1.38 percent to $6,069.00 a tonne.
Reporting by Trevor Hunnicutt; Additional reporting by Dhara Ranasinghe, Tom Finn and Helen Reid in London and Andrew Galbraith in Shanghai; Editing by David Gregorio and Dan Grebler