Updates shares, adds context, analyst comments in paragraph 4-6, 8

Jan 8 (Reuters) - Shares in European arms makers rose to a fresh record high on Thursday after President Donald Trump called for higher U.S. defence spending and said U.S. defence contractors were not permitted to pay dividends or buy back stock until they sped up weapons production.

Trump said on Wednesday that after negotiations with U.S. senators and political representatives, he has determined that the military budget for next year should be $1.5 trillion.

An index of European aerospace and defence companies .SXPARO rose as much as 2.1%, hitting a new all-time high, but pared some of those gains and was up around 1% by 0952 GMT.

The index has rallied sharply since Russia's 2022 full-scale invasion of Ukraine, driven by the prospect of more spending on defence in Europe.

Despite a pullback from October it rose around 57% last year and started 2026 on a strong footing as sentiment was buoyed by U.S. military action in Venezuela and Trump's comments on Greenland.

"Geopolitics is the inescapable story of 2026 thus far," said Neil Wilson UK investor strategist at Saxo Bank.

"Clearly defence stocks are the play - along with rare earths."

BAE SYSTEMS LEADS GAINS AMONG EUROPEAN DEFENCE NAMES

As well as the call for higher defence spending, the White House issued an executive order on Wednesday saying defence contractors were not permitted to pay dividends or buy back stock until they speed up weapons production.

Shares in U.S. defence companies fell on the news.

Trump's order has significant implications for U.S. defence contractors that may foster a rotation to UK defence companies, Ben Bourne, an analyst from Investec, said in an emailed comment.

BAE Systems BAES.L, Chemring CHG.L and Avon Technologies AVON.L have the highest U.S. exposure, Bourne added, noting that Cohort CHRT.L, Babcock BAB.L and Qinetiq QQ.L could also benefit.

Shares in BAE Systems, Britain's biggest defence company, were leading gains on the index, rising 6.3% to October highs.

Defence contractor Chemring was also up some 2%.

Elsewhere, Italy's Leonardo LDOF.MI, Sweden's SAAB SAABb.ST, Germany's Rheinmetall RHMG.DE, Renk R3NK.DE were up between around 1% and 3%.

And shares of some U.S. defence companies bounced back in premarket trading on Thursday, with Northrop Grumman NOC.N and Lockheed Martin LMT.N up more than 6% each.

RTX RTX.N and Kratos Defense KTOS.O gained 4.6% and 7.1%, respectively, while General Dynamics GD.N and L3Harris Technologies LHX.N also rose in light volumes.

(Reporting by Anna Pruchnicka, additional reporting by Shashwat Chauhan, editing by Alun John)

((anna.pruchnicka@thomsonreuters.com; +48 58 769 65 14;))