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UPDATE 1-European shares tumble on China rare earth warning

Medha Singh

* STOXX 600 hits 2-1/2 month lows

* On course for 5% fall in May, first monthly fall this year

* All sub-indexes down, with miners lagging

* U.S. Treasury yields at the lowest since September 2017

* German unemployment rises unexpectedly in May (Adds quote, details; Updates prices)

May 29 (Reuters) - European shares sank to ten week lows on Wednesday as Chinese newspapers warned Beijing was ready to use its supply of rare earths in an increasingly bitter trade dispute with the United States, sending investors scurrying for perceived safe havens for capital globally.

By 0825 GMT, the pan-European STOXX 600 index lost more than 1%, with Spanish and French markets leading the falls, down more than 1.5% apiece.

Frankfurt's DAX, typically sensitive to trade headlines, fell 1.3% while the FTSE 100 performed only slightly better as its big industrial miners and oil producers slid.

Stock markets are suffering their worst month since a quarter-long sell-off at the end of last year.

Donald Trump's tit-for-tat war with Beijing over everything from microchips to soy beans has seen European markets sink more than 5% so far in May, putting the STOXX on course for its first monthly fall this year.

In a commentary headlined "United States, don't underestimate China's ability to strike back", the official People's Daily noted the United States' "uncomfortable" dependence on rare earths from China.

"Even if China doesn't follow up, the threat (on rare earths) will increase tensions between the two sides and that is likely to drive investors out of stocks and into government bonds," said David Madden, market analyst at CMC Markets UK.

At the heart of the concern over trade is the threat that it will cripple already slowing global growth, driving major western economies into recession and preventing China from filling the gap as it has done for much of the past two decades.

The latest signs of trade friction caused an inversion of a part of the U.S. yield curve overnight, normally seen as a leading indicator of an impending recession.

"The movement in the bond market really spooked investors," Madden said.

Taking the biggest hit from the risk aversion were Europe's mining and auto stock indexes, down 2% and 0.9% respectively, while technology was weighed down by semiconductor shares.

Rare earths are a group of 17 chemical elements used in everything from high-tech consumer electronics to military equipment and Chinese production accounted for 80% of U.S. imports of the substances between 2014 and 2017.

Europe's bank index also shed 1.3% as Italy's dispute over its budget with the European Union continued to hurt sentiment.

Latest data showed German unemployment rose unexpectedly in May for the first time in nearly two years, in a sign that a slowdown in Europe's largest economy is spilling over to the labour market.

The top gainer on the STOXX 600 was radiation therapy equipment maker Elekta, which reported fourth-quarter core earnings above market expectations.

Prosiebensat.1 rose more than 4% after Italy's Mediaset announced it had acquired 9.6% of the share capital of the German broadcaster. (Reporting by Medha Singh and Agamoni Ghosh in Bengaluru; editing by Patrick Graham)