Escalating trade dispute sinks European shares

* Worst day in two weeks for European shares

* STOXX 600 still up 1 percent on the week on ECB rally

* Rolls Royce (LSE: RR.L - news) drives aerospace stocks to record high

* Autos among leading gainers, banks fall (Updates prices, adds quotes, details)

By Danilo Masoni and Helen Reid

MILAN/LONDON, June 15 (Reuters) - European shares sank on Friday as a tariff dispute between the United States and China escalated, triggering a sharp selloff in trade-sensitive commodities stocks.

Thursday's European Central Bank meeting had led investors to push back expectations for an interest rate increase, spurring a rally across European stocks.

But on Friday U.S. President Donald Trump announced tariffs on $50 billion worth of Chinese imports and Beijing threatened to respond in kind, stopping the market in its tracks.

The pan-European STOXX 600 index ended the day down 1 percent but still sealed its strongest week in five, however, with investors comforted by the ECB's "dovish" taper of quantitative easing.

Euro zone stocks enjoyed their best weekly gains in two and a half months, boosted in part by a sharp drop in the euro post-ECB.

In the previous three weeks, the STOXX posted losses as investors were put off by worries over an anti-establishment government in Italy, the euro zone's third largest economy, and concern over slowing growth in the region.

"We shouldn't overstate the nature of today's announcement as an escalation towards a fully-fledged trade war," said Geoffrey Yu, head of the UK chief investment office at UBS Wealth Management.

"Markets have taken the new tariffs in their stride so far, with the Federal Reserve's interest rate hike and the ECB's phasing out of quantitative easing both creating greater market interest."

Trade concerns did weigh on mining stocks on Friday, with the pan-European basic resources sector sinking 3.3 percent in its worst daily fall since November 2016.

Banks were the biggest drag on the market, falling 1.9 percent on souring sentiment over international trade and U.S.-China relations.

Euro zone banks had already weakened on Thursday on disappointment that the ECB would keep interest rates ultra-low for longer, as banks' margins suffer from negative interest rates.

UBS (LSE: 0QNR.L - news) , BBVA (LSE: 931474.L - news) , BNP Paribas (LSE: 0HB5.L - news) and Barclays (LSE: BARC.L - news) were the biggest drags, falling 1.3 to 3 percent.

Among single stocks, Rolls Royce jumped 7.6 percent higher after saying it would exceed its 2020 guidance as it announced new ambitious mid-term goals.

The maker of engines for aircraft and ships has been in turnaround mode since 2015, and following a cost-saving plan announced on Thursday, said the foundation was in place for higher returns in future.

Its gains helped Europe's aerospace and defence index , which also benefits from strength in the dollar, reach a record high before falling back 0.1 percent.

Plane maker Airbus also reached a record high, but ended the day down 0.9 percent on the trade tariff fears.

Airbus and its U.S. counterpart Boeing (NYSE: BA - news) have been particularly sensitive to protectionist developments due to their deep and broad global supply chains.

A rare gainer, Tesco (Frankfurt: 852647 - news) rose 1.9 percent after Britain's largest retailer said a drive to lower prices had boosted its quarterly sales, in a warning for rivals three years after the firm embarked on a turnaround programme.

French tele-services provider Teleperformance jumped 5.8 percent to a record high after agreeing to buy India-based Intelenet from U.S. private equity firm Blackstone (NYSE: BX - news) for $1 billion.

Speciality pharmaceuticals firm Indivior (Frankfurt: 2IVA.F - news) sank 27 percent, leading losers on the STOXX, after rival Dr Reddy's Laboratories received U.S. approval to launch a generic version of its key opioid-addiction treatment. (Reporting by Danilo Masoni, editing by Gareth Jones)