The Pentagon responded by preparing for a new round, spelling out more clearly the expanded fuel-carrying capabilities it was seeking, among other things.

At stake, among other things, are Boeing efforts to curb EADS’ penetration of the rich U.S. military market and a possible step toward production of Airbus airliners in the United States to cash in on exchange rate fluctuations.

The Air Force calls acquiring new tankers its No. 1 acquisition priority. The new fleet would phase out Boeing-built KC-135 tankers, which have an average age of 47 years. Tankers are used to refuel other planes in mid-air, a critical component of projecting U.S. power around the globe.

Rather than hand over "an incomplete and possibly contested process," Gates said he wanted to give the next administration a free hand for everything from the military requirements. to funding. to how to weigh the bids.

MISTAKES AND MISSTEPS

"Over the past seven years the process has become enormously complex and emotional -- in no small part because of mistakes and missteps along the way by the Department of Defence," Gates told the House Armed Services Committee while discussing the wars in Iraq and Afghanistan.

"It is my judgment that in the time remaining to us, we can no longer complete a competition that would be viewed as fair and objective in this highly charged environment," he said.

What Gates called a "cooling off" period was a gain for Chicago-based Boeing. It had threatened to withdraw from the now-cancelled competition unless given six months to prepare a new bid. It said the Air Force had made clear it was now seeking a larger plane than the modified 767 it originally offered.

Boeing cheered Gates’ decision, terming it in the best interest of U.S. forces to give "the appropriate time for this important and complex procurement to be conducted in a thorough and open competition."

The company has been considering substituting the bigger 767-400 or even its 777 aircraft, in place of its 767-200ER model.

Northrop Grumman, on the other hand, said it was extremely disappointed, "especially on behalf of our men and women in uniform who will now be denied a critically needed new tanker for years."

EADS had no immediate comment. Northrop’s tanker would use an Airbus A330 airframe that would be assembled in Mobile, Alabama.

The A330s are currently put together in Toulouse, France, using mainly French, German, British and Spanish parts. The Pentagon issued a stop-work order on Northrop’s contract after Boeing challenged the choice.

The tanker contest has pitted lawmakers against each other as they eye the jobs a win would bring to their districts.

Sen. Richard Shelby, a Republican from Alabama, deplored the cancellation of the contest which jeopardized EADS’ plans for Mobile, Alabama. "This approach is irresponsible, shortsighted and harmful to both the warfighter and the nation," he said.

Rep. Rick Larsen, a Democrat from Washington state, home to much Boeing production, hailed the decision as great news and a step toward "fair competition and a level playing field for Boeing."

PRESIDENTIAL HOPEFULS

Republican presidential hopeful John McCain, a member of the Senate Armed Services Committee, led a drive in 2003 to kill an initial $23.5 billion Air Force plan to lease and buy 100 modified Boeing 767s as tankers.

McCain, an Arizona Republican, denounced the original no-bid, sole-source plan as a taxpayer ripoff and sweetheart deal for Boeing, then reeling from drops in demand for commercial airliners after the September 11, 2001 attacks.

The lease-purchase deal collapsed amid a scandal that sent two Boeing executives, including the Air Force’s one-time No. 2 arms buyer, to prison on conflict of interest charges.

Neither the campaign of McCain nor Democratic presidential candidate Sen. Barack Obama, who comes from Illinois, the home state of Boeing’s headquarters, immediately responded to requests for comment.

"Given McCain’s history in regard to this program, one might handicap a slight advantage to Northrop/EADS should he be elected," said Harry Nourse of Bank of America Securities.

"If Obama wins, you could see some implementation of the ’Buy America’ philosophy, which might favour Boeing," he said.

(With additional reporting by Bill Rigby in New York and Tim Hepher in Paris; editing by Tim Dobbyn)