*

Parties agree spending shake-up, sources say

*

Special funds mulled to circumvent debt brake

*

White House bust-up heightens sense of urgency

(Adds Merz comments in paragraphs 2-4, 8; Green call for 3

billion euros for Ukraine in paragraph 10)

By Andreas Rinke and Friederike Heine

BERLIN, March 3 (Reuters) - The prospect of a military

spending boom by Germany unprecedented since the Cold War sent

Europe's defence stocks soaring after Reuters reported the

likely next government was mulling a fiscal sea change for

Europe's biggest economy.

Germany's likely next chancellor, Friedrich Merz, did not

confirm that his conservatives and the Social Democrats were

mulling setting up special funds worth nearly a trillion euros

to finance urgent defence and infrastructure spending.

But he said spending decisions had to be taken "with great

urgency" after U.S. President Donald Trump and his deputy

harangued Ukraine's President Volodymyr Zelenskiy in the Oval

Office on Friday, crystalising European fears that Washington

had cooled on backstopping Europe's defence.

"We must now show that we are in a position to act

independently in Europe," he said. "The question of defence has

priority."

News of the proposed funds sent shares in defence

contractors including Thyssenkrupp, Hensoldt

, Renk ( RNKGF ), Rheinmetall, BAE Systems

and Leonardo jump by double-digit percentages

on Monday morning.

Neither party has confirmed that a special fund for defence

worth 400 billion euros ($417 billion) and for infrastructure

worth as much as 500 billion euros were under discussion, a sum

which combined would amount to 20% of German GDP.

"There is an enormous need for investment and we won't

create consent for it if we just invest in defence," said SPD

General Secretary Matthias Miersch on Monday. "The two need to

be considered together."

Merz made no comment on the numbers which, if confirmed,

would amount to an extra 2% of economic output in spending over

the next 10 years, kicking in from next year.

"This would be about as much as the country has invested

in East Germany since reunification," Deutsche Bank wrote in a

note. "It would be a fiscal regime shift of historic

proportions."

Bild newspaper reported that an extraordinary session of

parliament might be called for next Monday, which would allow

the measure to be passed with the backing of the Greens - who on

Monday urged Chancellor Olaf Scholz's outgoing government to

approve a further 3 billion euros' funding for Ukraine.

After the new parliament is seated this month, the

defence-sceptical Left party's support will be needed to reach

the necessary two-thirds majority.

For decades, Germany has been a defence laggard, until 2023

spending less than NATO's target of 2% of economic output on

defence, with Russia's invasion of Ukraine and Scholz's defence

"Zeitenwende" or sea change only bringing modest changes.

The use of a special fund - effectively a credit line -

reflects the difficulties in circumventing a constitutional

spending cap that limits the amount of new debt German

governments can take on each year.

The soaring shares reflect investor confidence that the

makers of military vehicles, ammunition and other battlefield

kit will be big winners from the bonanza.

Scholz's previous attempts to boost military spending also

relied on a special fund, formally separate from Germany's 2

trillion euros in public spending.

They are legally tricky: a court ruling against his use of

another fund paved the way for the collapse of his government

and the election he lost last month, while the state auditor has

called for their use to be reined in.

The economic impact of the defence fund would be modest in

the short term, Deutsche Bank wrote, since much of it would be

spent on imports.

The infrastructure fund, badly needed after years of

frugality have left much of Germany's public realm, from bridges

to railways, in a ragged state, would have a bigger impact.

($1 = 0.9602 euros)

(Writing by Thomas Escritt, Editing by Friederike Heine and

Angus MacSwan)