* Canadian dollar hits four-month high, Mexican peso gains
* European stocks follow Japanese higher on trade relief
* Italian budget worries hits bonds, euro
* Chinese manufacturing surveys tempers optimism
* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh
By Abhinav Ramnarayan
LONDON, Oct 1 (Reuters) - Optimism about a reconstituted free trade agreement among the United States, Canada and Mexico and what it could mean for trade relations elsewhere helped world markets kick off the fourth quarter of the year in a positive vein.
Worries on Italian politics and Chinese manufacturing tempered the optimism, but the last-gasp deal to save NAFTA was enough to put world stocks in the black.
The United States and Canada salvaged NAFTA as a trilateral pact with Mexico, rescuing a $1.2 trillion open-trade zone that had been about to collapse after nearly a quarter century .
Japan's Nikkei rose 0.5 percent to a 27-year high and European stocks were up overall despite losses on Italian markets on political concerns.
The Canadian dollar was up 0.65 percent against the dollar to a four-month high and the Mexican peso hit its highest in over seven weeks.
"The trade deal is helping risk appetite across the board, especially the Canadian dollar, and that will likely lift appetite for emerging-market currencies across the board," said Manuel Oliveri, a currency strategist at Credit Agricole in London.
A pan-European index of shares was up 0.25 percent, though gains were curbed by concern over how the Italian government's spending plans would affect relations with the European Union.
Italian bond yields extended last week's rise and stocks fell on a report that the EU is set to reject Italy's budget plans in November and open a procedure against the country's public accounts.
The closely watched spread between Italian and German 10-year bond yields was at 270 basis points, over 30 bps wider than this time last week.
"It is quite clear that the European Commission will not like (the budget proposal)," said Commerzbank rates strategist Michael Leister. "Brussels will give its opinion, which we think won’t be positive and ... the ratings agencies will opt for a similar stance. A downgrade is our base case."
The euro was also hit by worries about a rise in Italy's fiscal deficit, dropping below the $1.16 mark having lost 1.2 percent last week and off three-month high of $1.18155 touched a week ago.
Also casting a shadow were two surveys on Sunday that showed growth in Chinese manufacturing sputtered in September as domestic and export demand softened.
As a result, MSCI's broadest index of Asia-Pacific shares outside Japan fell 0.25 percent. China's financial markets were closed for a holiday, as was Hong Kong's stock exchange.
"The escalation of trade tensions between the U.S. and China recently has likely weighed on purchasing managers' sentiment as reflected by softer readings in trade-related sub-indices," economists at Bank of America Merrill Lynch said in a note.
Oil prices held their gains, with international benchmark Brent briefly hitting a four-year high, as U.S. sanctions on Tehran squeezed Iranian crude exports, tightening supply even as other key exporters increased production.
Brent crude futures rose 0.6 percent to as high as $83.25 per barrel, the highest since November 2014, before trading flat on the day at $82.72. (Reporting by Abhinav Ramnarayan, additional reporting by Hideyuki Sano in Tokyo and Saikat Chatterjee and Virginia Furness in London; editing by Larry King)