Tesco issued its first profit warning in living memory on Thursday, sending shares in British grocers tumbling on fears the world's third-biggest retailer would launch a price war to fight back from its worst Christmas in decades.

Chief executive Phil Clarke said trading profit in 2012/13 would be flat, compared with forecasts for a 10 percent rise, as Tesco invested hundreds of millions of pounds lowering prices, expanding its online business and improving customer service.

This is the first time that Tesco is deliberately taking profit margins lower that we can remember ... with the likely outcome a reduction in industry profitability, Espirito Santo analyst Caroline Gulliver said.

Shares in Tesco, previously one of Britain's most consistent companies in growing earnings, plunged as much as 16 percent to a 33-month low of 324.25 pence, wiping 4.8 billion pounds ($7.4 billion) off its stock market value. Rivals J Sainsbury and Wm Morrison also fell over 5 percent.

WEAKNESS WIDESPREAD

Tesco's warning was accompanied by a raft of weak trading updates from British store groups including Home Retail-owned Argos, bicycles-to-car parts group Halfords and Mothercare, underscoring how cash-strapped Britons have been cutting back spending on non-essentials.

A surprise slump in November industrial output also raised fears the British economy shrank last quarter.

Disposable incomes across much of Europe are being squeezed by rising prices, muted wages growth and government austerity measures, with consumers also worried about the fallout from the euro zone sovereign debt crisis.

Belgian grocer Delhaize said on Thursday it was axing 5,000 jobs after fourth-quarter sales fell just short of forecasts in its key U.S. and Belgian markets.

Tesco, which accounts for about one in ten pounds spent in British shops and makes over 70 percent of trading profit in its home market, said sales at British shops open over a year dropped 2.3 percent, excluding fuel and VAT sales tax, in the six weeks to January 7. A 0.9 percent fall had been forecast.

It is not what I wanted for Christmas, said chief executive Phil Clarke, adding sales were hit by weak consumer spending, a muted response to price cuts the group made in September and deep promotions by rivals.

Panmure analyst Philip Dorgan said weakness in Britain could undermine Tesco's expansion in fast-growing markets like China and slashed his pretax profit forecasts by 15 percent for the years ending February 2013 and February 2014.

This is the nightmare scenario, he said. If the UK's profits keep falling, then it will not be able to invest so much overseas, so long-term growth will slow and returns will significantly undershoot targets.

NOT GETTING BETTER

Clarke said Tesco's problems were partly due to the pressure on British shoppers. The group sells a higher proportion of discretionary non-food goods like clothing and electricals than rivals such as Morrison and Sainsbury, both of which reported small rises in underlying Christmas sales this week.

He saw little respite for consumers in the year ahead.

It is going to be broadly the same (as in 2011). I cannot see it being any better, he told reporters on a conference call, adding Tesco would open fewer hypermarkets because shoppers were cutting back on big shopping trips.

Some of Tesco's weak performance was due to its Big Price Drop campaign in September, Clarke said. While this attracted extra customers, it had not yet tempted enough to offset the drop in takings.

The group will cut more prices in the months ahead, he said.

Tesco had also suffered from promotions and couponing by rivals as well, Clarke said, questioning whether some of them would see much benefit to profit from rising sales.

The British Retail Consortium had said on Tuesday retail sales rose a better-than-expected 2.2 percent in December, but that this was partly due to heavy discounting.

Tesco, which lags only French group Carrefour and U.S. industry leader Wal-Mart by annual sales, said group sales rose 5.2 percent, helped by growth in Asia, eastern Europe and the United States.

Carrefour and German retailer Metro, which have both warned on profit in recent months, report fourth-quarter sales next week.

Tesco, with over 5,300 stores in 14 countries, said on Tuesday it was mothballing 12 stores at its loss-making Fresh & Easy business in the United States due to weak local economies, adding it remained committed to the chain.

(Additional reporting by James Davey; Editing by Dan Lalor)