(Adds G7 finance ministers' statement, markets reaction, paragraphs 4, 10, 13,)
* Putin threatens invasion to protect Russian citizens
* Russian forces seize Crimea, no sign of them elsewhere
* Demonstrators fly Russian flag in south, east Ukraine
* Ukraine calls up reserves, potentially all men up to 40
* Oil, wheat futures jump on rising tensions
By Natalia Zinets and Alissa de Carbonnel
KIEV/BALACLAVA, Ukraine, March 2 (Reuters) - Ukraine mobilised for war on Sunday and Washington threatened to isolate Russia economically after President Vladimir Putin declared he had the right to invade his neighbour in Moscow's biggest confrontation with the West since the Cold War.
"This is not a threat: this is actually the declaration of war to my country," Ukrainian Prime Minister Arseny Yatseniuk said in English. Yatseniuk heads a pro-Western government that took power in the former Soviet republic when its Moscow-backed president, Viktor Yanukovich, was ousted last week.
Putin secured permission from his parliament on Saturday to use military force to protect Russian citizens in Ukraine and told U.S. President Barack Obama he had the right to defend Russian interests and nationals, spurning Western pleas not to intervene.
Financial markets reacted to the escalating tensions when trading opened in Asia on Monday, with oil and wheat futures jumping and stock indexes falling.
Russian forces have already bloodlessly seized Crimea, an isolated Black Sea peninsula where Moscow has a naval base.
On Sunday, they surrounded several small Ukrainian military outposts there and demanded the Ukrainian troops disarm. Some refused, leading to standoffs, although no shots were fired.
As Western countries considered how to respond to the crisis, the United States said it was focused on economic, diplomatic and political measures, and made clear it was not seriously considering military action.
U.S. Secretary of State John Kerry will visit Kiev on Tuesday to show "strong support for Ukrainian sovereignty, independence, territorial integrity, and the right of the Ukrainian people to determine their own future, without outside interference or provocation", the State Department said in a statement.
The Group of Seven major industrialized nations, condemning the Russian intrusion into Ukraine, suspended preparations for the G8 summit that includes Russia and had been scheduled to take place in June in Sochi, site of the recent Winter Olympics.
Finance ministers from the G7 said they were ready to offer "strong financial backing" to Ukraine, provided the new government in Kiev agreed to pursue economic reforms sought by the International Monetary Fund.
Analysts said U.S. economic sanctions would likely have little impact on Russia unless they were paired with strong measures by major European nations, which have deeper trade ties with Moscow and are dependent on Russian gas.
But EU officials said the European Union was unlikely to match the United States in threatening sanctions against Russia when its foreign ministers meet to discuss Ukraine on Monday, instead pushing for mediation between Moscow and Kiev.
Wheat futures spiked more than 4 percent on Monday on fears of disruption to shipments from one of the world's key exporting regions. Oil rose as much as 2 percent, while U.S. stocks futures fell 1 percent.
MORE DEMONSTRATIONS IN EASTERN UKRAINE
With Russian forces in control of majority ethnic Russian Crimea, the focus is shifting to eastern swaths of Ukraine, where most ethnic Ukrainians speak Russian as a native language.
Those areas saw more demonstrations on Sunday after violent protests on Saturday, and pro-Moscow activists hoisted flags for a second day at government buildings and called for Russia to defend them.
Russia has staged war games with 150,000 troops along the land border, but they have so far not crossed. Kiev said Russia had sent hundreds of its citizens across the border to stage the protests.
Ukraine's security council ordered the general staff to immediately put all armed forces on highest alert. But Kiev's small and under-equipped military is seen as no match for Russia's superpower might.
The Defence Ministry was ordered to stage a call-up of reserves, meaning theoretically all men up to 40 in a country with universal male conscription, although Ukraine would struggle to find extra guns or uniforms for many of them.
Kerry condemned Russia for what he called an "incredible act of aggression" and brandished the threat of economic sanctions.
"You just don't, in the 21st century, behave in 19th century fashion by invading another country on a completely trumped-up pretext," Kerry told the CBS programme "Face the Nation".
He said Moscow still had a "right set of choices" to defuse the crisis. Otherwise, G8 countries and other nations were prepared to "to go to the hilt to isolate Russia".
"They are prepared to isolate Russia economically. The rouble is already going down. Russia has major economic challenges," he said. Kerry mentioned visa bans, asset freezes and trade isolation as possible steps.
Obama held calls with German Chancellor Angela Merkel, British Prime Minister David Cameron and Polish President Bronislaw Komorowski. The leaders expressed "grave concern" over Russia's action and stressed that "dialogue between Ukraine and Russia should start immediately, with international facilitation as appropriate", the White House said.
Ukraine's envoy to the United Nations said Kiev would ask for international military support if Russia expanded its military action in his country.
At Kiev's Independence Square, where anti-Yanukovich protesters had camped out for months, thousands demonstrated against Russian military action. Speakers delivered rousing orations and placards read: "Putin, hands off Ukraine!"
"If there is a need to protect the nation, we will go and defend the nation," said Oleh, an advertising executive cooking over an open fire at the square where he has been camped for three months. "If Putin wants to take Ukraine for himself, he will fail. We want to live freely and we will live freely."
The new government announced it had fired the head of the navy and launched a treason case against him for surrendering Ukraine's naval headquarters to Russian forces in the Crimean port of Sevastopol, where Moscow has a major naval base.
REACTION FROM THE WEST
Obama spoke to Putin for 90 minutes by telephone on Saturday after the Russian leader declared he had the right to intervene and quickly secured unanimous approval from his parliament.
The Kremlin said Putin told Obama that Russian speakers were under threat from Ukraine's new leaders, who took over after Yanukovich fled huge protests against his repression and rejection of a trade deal with the European Union.
Putin reiterated that stance in a telephone call with Merkel on Sunday, the Kremlin said, adding he and Merkel agreed that Russia and Germany would continue consultations to seek the "normalisation" of the situation.
But in a sign of concern among Russian liberals, members of Putin's own human rights council urged him on Sunday not to invade Ukraine, saying threats faced by Russians there were not severe enough to justify sending in troops.
Ukraine, which says it has no intention of threatening Russian speakers, has appealed for help to NATO, as well as to Britain and the United States as co-signatories with Russia to a 1994 accord guaranteeing Ukraine's security.
After an emergency meeting of NATO ambassadors in Brussels, the alliance called on Russia to bring its forces back to bases and refrain from interfering in Ukraine.
Despite expressing "grave concern", NATO did not agree on any significant measures to apply pressure on Russia, with the West struggling to come up with a forthright response that does not risk pushing the region closer to military conflict.
"We urge both parties to immediately seek a peaceful solution through bilateral dialogue, with international facilitation ... and through the dispatch of international observers under the auspices of the United Nations Security Council or the Organisation for Security and Cooperation in Europe," NATO said in a statement.
So far, the Western response has been largely symbolic. Some countries recalled ambassadors. Britain said its ministers would stay away from the Paralympics, which begin in Sochi on Friday.
"Right now, I think we are focused on political, diplomatic and economic options," a senior U.S. official told reporters.
"Frankly our goal is to uphold the territorial integrity and sovereignty of Ukraine, not to have a military escalation," he said.
German Foreign Minister Frank-Walter Steinmeier urged world leaders on Sunday to work to calm the crisis and defended Russia's membership of the G8, saying it enabled the West to talk directly with Moscow.
RUSSIANS IN CRIMEA
Ukraine's military is ill-matched against its neighbour. Britain's International Institute of Strategic Studies estimates Kiev has fewer than 130,000 troops under arms, with planes barely ready to fly and few spare parts for a single submarine.
Russia, by contrast, has spent billions under Putin to upgrade and modernise the capabilities of forces that were dilapidated after the breakup of the Soviet Union. Moscow's special units are now seen as equal to the best in the world.
In Crimea, Ukraine's tiny contingent made no attempt to oppose the Russians, who bore no insignia on their uniforms but drove vehicles with Russian plates and seized government buildings, airports and other locations in the past three days.
Kiev said its troops were encircled in at least three places and pulled its coast guard vessels out of Crimean ports. Ukraine said its naval fleet's 10 ships were still in Sevastopol and remained loyal to Kiev.
Scores of Russian troops were camped outside a base of Ukrainian troops at Perevalnoye, on a road from Crimea's capital, Simferopol, towards the coast.
A representative of the base commander said troops on both sides had reached agreement so no blood would be shed.
"We are ready to protect the grounds and our military equipment," Valery Boiko told Reuters television. "We hope for a compromise to be reached, a decision, and as the commander has said, there will be no war."
Igor Mamchev, a Ukrainian navy colonel at another small base outside Simferopol, said a truckload of Russian troops had arrived at his checkpoint and told his forces to lay down their arms.
"I replied that, as I am a member of the armed forces of Ukraine, under orders of the Ukrainian navy, there could be no discussion of disarmament. In case of any attempt to enter the military base, we will use all means, up to lethal force," Mamchev told Ukraine's Channel 5 TV.
A unit of Ukrainian marines was also holed up in a base in the Crimean port of Feodosia, where they refused to disarm.
Elsewhere on the occupied peninsula, the Russian troops assumed a lower profile on Sunday after the pro-Moscow Crimean leader said overnight the situation was now "normalised".
Putin's justification citing the need to protect Russian citizens was the same as he used to launch a 2008 invasion of Georgia, where Russian forces seized two breakaway regions.
In Russia, state-controlled media portray Yanukovich's removal as a coup by dangerous extremists funded by the West and there has been little sign of dissent.
(Additional reporting by Peter Graff, Sabina Zawadzki, Pavel Polityuk, Timothy Heritage and Stephen Grey in Kiev, Lina Kushch in Donetsk, Peter Apps and Guy Faulconbridge in London, Will Dunham, Arshad Mohammed and Matt Spetalnick in Washington, Lou Charbonneau at the United Nations, and Justyna Pawlak and Luke Baker in Brussels; Writing by Peter Graff, Paul Taylor, Frances Kerry and Peter Cooney; Editing by Alex Richardson and Paul Tait)
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