(Reuters) -A sharp rally in defence shares lifted Britain's FTSE 100 to record highs on Monday as investors cheered the possibility of a military spending surge in Europe.

The blue-chip FTSE 100 gained 0.7% to touch an all-time closing high, while the midcap FTSE 250 gained 0.3%.

European leaders agreed on Sunday they needed to spend more on defence as France and Britain prepared to present a proposal for a partial one-month truce between Russia and Ukraine.

The agreement comes just two days after Ukrainian President Volodymyr Zelenskiy clashed with U.S. President Donald Trump. European leaders agreed they must spend more on defence to show Trump the continent can protect itself.

The FTSE 350 aerospace & defence index jumped 8.1% to a record high. The sector has soared over 25% so far this year.

BAE Systems was the top gainer in the FTSE 100 with a 14.6% jump, while Rolls-Royce Holdings climbed 4.4%, tracking moves in defence shares across Europe.

The gains were also supported by a Reuters report that said the parties in talks to form Germany's new government are considering setting up a special fund for defence.

Meanwhile, British factories cut staff at the fastest pace in nearly five years last month, according to a survey which also showed manufacturers turned the most positive in six months as they hoped for a pick-up in the economy.

The FTSE 350 precious metal mining index rose 1.6%, as gold prices rose driven by a weaker dollar and safe-haven buying amid concerns over Trump's tariff policies. [GOL/]

Senior Plc rose 8.5% after the engineering firm said it was in advanced negotiations with a small number of parties for the sale of its aerostructures business.

Bunzl fell 8.8% to its lowest since August after the distribution and services company reported a fall in annual profit.

(Reporting by Lisa Mattackal and Sanchayaita Roy in Bengaluru; Editing by Shinjini Ganguli and Angus MacSwan)