*

Euro hits 3-1/2 month high

*

Dax futures jump 2%; EuroSTOXX 50 futures up 1.5%

*

Bund futures slide 1%

(This March 4 story was updated on March 5 to updates prices to

Asia morning)

By Dhara Ranasinghe and Alun John

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

futures rallied, 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 hit $1.0637 in the Asia session on

Wednesday, its highest level in more than three months. Against

Britain's pound, the euro rose to 83.12 pence.

German and European stock futures bounced from Tuesday

lows, with Dax futures up 2% in Asia trade and EuroSTOXX

50 futures up 1.5%.

"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."

The benchmark Dax index closed down 3.5% on

Tuesday on worries about U.S. tariffs.

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 the euro/dollar pair 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 and slid a further 1.1% in Asia trade on Wednesday,

touching the lowest level since mid-January.

"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)