* European shares fall one percent * Italian labour reform talks in focus * Euro edges down; Treasury yields underpin dollar By Richard Hubbard LONDON, March 20 (Reuters) - The euro dipped to just below recent highs and European stocks fell on Tuesday amid concern about the scale of China's growth slowdown, while investors eyed crucial talks between Italy's government and unions on labour reforms. Prime Minister Mario Monti's meeting with union bosses could make or break his brief tenure as head of a government struggling to pay down massive debts and find ways to revive an economy in which factory output has fallen sharply. Ahead of the meeting, equity investors were trimming positions after shares rose to eight-month peaks on signs of a recovery in the giant U.S. economy and after big improvements in corporate balance sheets. "Strategically, I am bullish on equities," Neil Dwane, chief investment officer for Europe at Allianz Global Investors/RCM, said. "The thing is that they have rallied quite a long way, so it's harder to be as confident when you think: have we solved any of the economic issues?" The FTSE Eurofirst 300 was down 0.5 percent at 1,099.71 points after snapping a four-session winning streak on Monday that saw it touch levels last seen in July. Traders' growing nervousness about the outlook could be seen in the Euro STOXX 50 volatility index, a key gauge of sentiment, which jumped 4.3 percent after three days of falls. The higher the volatility index, the lower the investor appetite to take on more risk. RECOVERY HOPES IN THE BALANCE Meanwhile U.S. Treasury yields, which have risen sharply in the past week on the improved U.S. economic outlook and reduced expectations of further monetary easing in the near term, also dipped on Tuesday but the fall was expected to be short lived. "I think that movement (in U.S. Treasury yields)...is definitely a confirmation that the market is switching much more in terms of its mentality towards a recovery mentality," Graham Neilson, chief investment strategist at Cairn Capital said. "I think yields are going to go higher from here as well." The 10-year U.S. Treasury yield, which moves inversely to price, stood at 2.35 percent after rising as high as 2.392 percent on Monday, its highest level since late October. Higher Treasury yields and concerns over the impact of China's economic slowdown on the world economy have helped lift the dollar against basket of currencies. The dollar index was up 0.3 percent to 79.73. The euro dipped 0.35 percent to just under $1.32, over half a cent below one-week highs. German government bond yields followed Treasuries and dipped slightly as investors were lured back into the market after 10-year yields broke last week above 2 percent, the upper end of the year's trading range to that point. Among the weaker euro zone economies, Italian bonds rose on wariness about the labour talks, and 10-year yields were last up 4.2 bps at 4.88 percent. The equivalent Spanish yield was up 4 bps at 5.21 percent after ratings agency Moody's said Spain's fiscal outlook remained challenging despite recently softened deficit targets. Commodities were broadly weaker, with base and precious metals both edging down after the worries about a sharp slowdown in China grew when BHP Billiton, the world's biggest miner, noted signs of "flattening" iron ore demand there. Earlier this month China cut its 2012 growth target to an eight-year low of 7.5 percent, fuelling caution about demand for natural resources and heightening fears the euro zone crisis would hit global growth. Brent crude fell towards $124 a barrel on Tuesday as signs of increased supply from Saudi Arabia and a return to pre-war exports from Libya added to the selling pressure on the market. Gold lost about 0.3 percent to $1,655.35 an ounce, snapping three straight sessions of gains.

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