West Germany described economic sanctions today as "an unsuitable instrument" to use against Libya as punishment for its alleged support of Palestinian terrorists.

The Reagan administration's latest appeal for international sanctions against Libya following last week's terrorist attacks on airports in Rome and Vienna drew similarly cool reactions from France and Britain. Italy was reported "assessing" its response, and Spain said it had not reached a decision.

At the same time, Wednesday's threat by Libyan leader Muammar Qaddafi to declare an "unending war" in the Mediterranean region if his country is attacked was widely dismissed in Western European capitals as exaggerated rhetoric.

The reluctance by governments on this side of the Atlantic to join a concerted campaign against Col. Qaddafi reflects continuing economic and trade links between Europe and Libya, a major oil supplier to many European countries. There is also general concern about jeopardizing the safety of tens of thousands of European citizens employed in Libya as technical experts, mainly in the oil industry.

In Libya today, the government staged mass anti-American demonstrations for the second straight day in a show of support for Qaddafi. Tripoli radio quoted the demonstrators as chanting, "We are ready to face any attack by the American imperialists and Zionists; we are ready to fight and join suicide squads."

Libya has been accused by both the United States and Israel of providing logistical support to the terrorists who attacked El Al check-in desks in Rome and Vienna last week. The coordinated assault, which resulted in 19 deaths, was described as a "heroic" action by the official Libyan news agency JANA.

Questioned about the Reagan administration's call for sanctions against Libya, a French Foreign Ministry spokesman said that similar appeals had met with little success in the past. He noted that Washington had done nothing to prevent several thousand U.S. citizens from traveling to Libya every year on business, despite a 1981 ban on such travel without official permission.

"There is a big difference between general declarations and their practical implementation," he said.

An equally cautious line was taken by the British government, which broke diplomatic relations with Tripoli and banned all arms shipments to Libya in April 1984 following the slaying of a London policewoman by shots fired from inside Libya's diplomatic mission.

A Foreign Office spokesman recalled a statement by Foreign Secretary Geoffrey Howe in 1984 expressing doubts that general economic sanctions against Libya would have any useful effect. He said that British policy on sanctions had not changed.

In Bonn, the government spokesman who described economic sanctions as "an unsuitable instrument" also promised that West Germany would join its allies in tracking down those responsible for last week's terrorist attacks.

"There is evidence of support for the terrorist attacks that points to the government of a third country," the spokesman, Norbert Schaefer, said. "Should that trail and the evidence become clear, we will agree with our allies on the necessary joint steps we shall take."

In Italy, the West European country with the closest economic ties to Libya, there was a general outburst of indignation last week after the Libyan news agency expressed support for the airport attacks. The official line since then, however, has been that Italy should not disrupt its relations with Libya.

Italy, which imported 84 million barrels of Libyan oil in 1984, exports a wide range of industrial products to Libya, including military equipment. The Libyan government has large financial holdings in Italy, including 15 percent of the giant Fiat automobile company.

About 15,000 Italians work in Libya, compared with about 5,000 Britons, 1,500 West Germans and 1,500 Americans.

In Washington, the Commerce Department reported that U.S. sales to Libya increased in the first 10 months of 1985, totaling almost $260 million in corn and machinery, compared with $164 million in the same period of 1984. U.S. purchases from Libya, the department reported, grew from $9.5 million in the 1984 period to $36.5 million, largely in refined petroleum products whose import was banned by President Reagan in November. In 1981, before Reagan banned imports of Libyan crude oil, U.S. purchases from Libya totaled $5.3 billion.

While Western European governments have had serious problems with Qaddafi in the past, they have taken the view that it is better to try to do business with him than to treat him as a diplomatic outcast. During the past two years the leaders of Spain, Austria, France, Greece and Italy have held meetings with Qaddafi despite U.S. calls for Libya's international isolation.

Libya's relations with France, in particular, have seesawed because of Qaddafi's military support for antigovernment rebels in the former French colony of Chad, but they have never been disrupted entirely. Libyan Foreign Minister Ali Treiki was received in Paris on an official visit in November despite his government's failure to carry out its side of an agreement with France on the withdrawal of foreign troops from Chad.

France's Socialist government was embarrassed last year when the French press published an effusive letter to Treiki from former foreign minister Claude Cheysson. Beginning "My dear Ali" and couched in the familiar second person singular, the letter included such gushing phrases as: "How many times in how many towns all over the four continents have I heard your voice on the telephone saying, 'Well, Claude, how are things?' . . . "

A new point of friction between Tripoli and Paris emerged today when separatist Kanaks on the French South Pacific island of New Caledonia announced that they will send a delegation to Libya this winter to attend a "summit conference" for liberation movements. Libya has supported Melanesian nationalists in the Pacific territory who are campaigning for full independence from France.

Libya's 73,000-member armed forces are equipped with French Mirage F1 aircraft and Italian tanks, ships and antiaircraft missiles. France has refused to sign new military contracts with Libya pending a peaceful solution in Chad.

The dilemma facing Western European governments was caught in an editorial in the Paris newspaper Le Monde that said the political will to isolate Qaddafi was likely to remain lacking as long as Libya remained attractive to western investors.