By Daren Butler

ISTANBUL (Reuters) - Kurdish militants said on Thursday media reports that its fighters had agreed to withdraw from Turkey as part of a peace pact to end their 28-year-old insurgency were lies and part of a psychological war.

The Sabah newspaper on Thursday said Kurdistan Workers' Party (PKK) guerrillas had agreed to withdraw to northern Iraq, where the group is based, by March 21 as part of peace talks with the PKK's jailed leader Abdullah Ocalan which started late last year.

Turkish Prime Minister Tayyip Erdogan has staked much political capital on the talks, given the potential for a nationalist backlash ahead of elections next year.

Media reports this week of a planned pullout have fuelled optimism about progress towards an end to the conflict which has killed some 40,000 people.

The PKK statement denied those reports as well as others in Turkish media that said Ankara was in talks with the militants in northern Iraq.

"The stories on this subject are also completely invented lies," the statement said. "These stories are activities in a deliberate psychological war aimed at manipulation."

Sabah, which is close to the government, said the PKK pullout would begin at the start of March when the weather in southeast Turkey turns milder. It said Ocalan, imprisoned on Imrali island south of Istanbul, was expected to issue a call within 10 days for the militants to declare a ceasefire after Kurdish politicians visit him.

Sabah did not name its source. Only a few officials are involved in the talks and have not disclosed details publicly, with the government wary of endangering its support ahead of local and presidential elections in 2014.

The PKK said it fully supported Ocalan representing the group in negotiations and called for him to be allowed to hold talks with the rest of the rebel leadership. He has been held in near isolation since he was captured in 1999.

"Talks between the leader Apo (Ocalan), our leadership and elements in the KCK (rebel umbrella group) must be facilitated for the process to advance properly in a way that will achieve results," it added.

KURDISH RIGHTS

The rebels took up arms in 1984 with the aim of creating a Kurdish state in southeastern Turkey. Declared a terrorist group by Ankara, the United States and the European Union, the PKK has since moderated its goal to one of autonomy.

PKK fighters withdrew from Turkish territory on Ocalan's orders after his 1999 capture as part of moves towards peace, but several hundred militants are thought to have been killed by security forces during the pull-out.

Erdogan gave his word this month that the same thing would not happen again. He also sought to strike a middle ground between supporting the peace process while maintaining a hardline against the militants.

"We will not give the slightest ground in the struggle against terrorism," he said in a speech on Thursday.

In return for the pull-out of militants and their ultimate disarmament, the government is expected to boost the rights of Kurds, who make up about 20 percent of Turkey's population of 76 million.

As part of those reforms, Turkey's parliament last week passed a law allowing defendants to use Kurdish in court in a move seen aimed at breaking a deadlock in the trials of hundreds accused of links to the PKK. [ID:nL6N0AU2VN]

On Thursday, a court in southeastern Turkey acquitted 98 mayors from the pro-Kurdish Peace and Democracy Party (BDP) of charges they belonged to a "terrorist organization" and had disseminated propaganda calling for better prison conditions for Ocalan.

President Abdullah Gul approved the law late on Wednesday, and a court in the southeastern city of Diyarbakir officially allowed the first Kurdish testimony on Thursday. Defendants have spoken in Kurdish before but on those occasions the court switched off their microphones.

(Additional reporting by Seyhmus Cakan in Diyarbakir, Turkey, and Ayla Jean Yackley in Istanbul; Writing by Daren Butler; Editing by Nick Tattersall and Rosalind Russell)