* FTSEurofirst 300, Euro STOXX 50 up 0.1 pct
* Euro STOXX 50 set for best monthly gain since Feb
* Tesco warning hits shares of food retailers
* Airlines down after volcano eruption in Iceland
By Francesco Canepa
LONDON, Aug 29 (Reuters) - European shares trimmed their early gains on Friday as euro zone inflation data slightly cooled market speculation about fresh monetary stimulus by the European Central bank.
Euro zone inflation dropped as expected to a fresh five year low in August, data showed on Friday, but it was not likely to force the ECB into immediate policy intervention next week.
Dovish comments by ECB's President Mario Draghi last week had fuelled market bets that the central bank was preparing to introduce new stimulus, such as purchases of government or corporate bonds, a measure known as quantitative easing (QE).
"I think what people realise is that for the ECB to engage in public-sector QE...the ECB has to see the whites of the eyes of deflation," Wouter Sturkenboom, investment strategist at Russell Investments, said.
"As the numbers come through, those condition are not being met so they realise the ECB is not going to...do a public sector QE, so they have to reassess their case."
Sturkenboom still expected the ECB to be ready to act if needed but argued the central bank would first wait to see the impact of its new long-term loan programme, which is due to start in September and aims to give banks an incentive to lend more to the real economy.
At 0956 GMT, the FTSEurofirst 300 index of top European shares was up 0.1 percent at 1,370.47 points, having traded as high as 1,376.58 points earlier.
The euro zone blue-chip Euro STOXX 50 was also up 0.1 percent, setting it on course to record its largest monthly gain since February at 1.6 percent, thanks to a bounce over the past two weeks.
Speculation about the ECB's next move had temporarily diverted the market's focus from events in eastern Ukraine, where a total of 2,593 people have been killed in fighting since it erupted in mid-April, according to a senior U.N. human rights official.
Yet the Ukrainian crisis remained a major headwind for European equities after Ukraine's president said on Thursday Russian troops had entered his country in support of pro-Moscow rebels who captured a key coastal town.
U.S. President Barack Obama spoke by phone on Thursday with German Chancellor Angela Merkel. The White House said the two agreed the United States and Europe should consider more sanctions against Moscow.
Shares in Britain's biggest retailer Tesco dropped 5.3 percent after it cut its profit forecast for the third time in three years and slashed its interim dividend by 75 percent.
The warning hit the shares of other UK supermarket chains, with Sainsbury down 2.9 percent and Morrisons down 4.2 percent.
Shares in European airlines fell after a small eruption occurred north of Iceland's Bardarbunga volcano, which prompted the Icelandic Met to raise the warning code for aviation to red, the highest level. In 2010, an ash cloud from Iceland's Eyjafjallajokull volcano closed much of Europe's airspace for six days.
Shares in Air France and easyJet were both down 1.5 percent.
Fiat shares gained 2.2 percent after the Italian carmaker said its merger with Chrysler was on track to go ahead as planned in October.
Fiat said it did not expect a 500 million euro cap on the money it set aside to pay off any dissenting shareholders over the merger would be breached.
Europe bourses in 2014: link.reuters.com/pap87v
Asset performance in 2014: link.reuters.com/gap87v
Today's European research round-up (additional reporting by Blaise Robinson in Paris, Stephen Jewkes in Milan and Victoria Bryan in Frankfurt; Editing by Toby Chopra)