LONDON, March 4 (Reuters) - The euro and European stock

futures rallied on Tuesday, while German Bund futures fell after

the parties hoping to form Germany's next government agreed to

create a 500 billion euro ($529.80 billion) infrastructure fund

and overhaul borrowing rules.

The news, which came after the close of European markets,

marks a tectonic spending shift to revamp the military and

revive growth in Europe's largest economy.

The euro rallied and was last trading at $1.0608,

more than 1% higher on the day and at its highest level in three

months. Against Britain's pound, the euro traded 0.4% higher at

82.91 pence.

German and European shares are expected to open higher on

Wednesday, as futures, which had fallen earlier in the day on

U.S. tariff worries, rose.

German Dax futures were last down 1.5% on the day after the

benchmark Dax index closed down 3.5%.

"It sends a clear signal that Germany is serious about its

defence, it sends a clear signal to Ukraine and at home it sends

a clear signal that Germany is serious about infrastructure

spending," said Berenberg chief economist Holger Schmieding.

"This is an excellent start for the new German government.

This strengthens Europe and should underpin euro gains although

there are trade risks to consider."

Deutsche Bank said on Tuesday it had turned more positive on

the euro's outlook following the headlines from Germany.

"The news flow is significant enough to now shift us into an

outright EUR/USD bullish view," Deutsche analysts said, adding

that the bank now targets euro/dollar at $1.10.

European defence company shares have soared in

recent days as momentum to ramp up defence spending across the

region gathers pace.

But for bond markets, signs that additional spending could

create more government bond issuance were expected to add upward

pressure on bond yields.

Germany's Bund futures turned sharply lower on the

news. They were last down 1%.

"Details around the announcement will of course be key. But

this is an important step to significantly ease German fiscal

policy and to start reversing years of underinvestment into the

domestic economy and on defence spending," said Marchel

Alexandrovich, economist at consultancy Saltmarsh Economics.

In addition, markets were processing a Reuters report that

U.S. President Donald Trump's administration and Ukraine plan to

sign a much-debated minerals deal.

($1 = 0.9438 euros)