Tesco, the world's third-biggest retailer, issued a profit warning after reporting its worst Christmas sales performance for decades, with the prospect of a price war sending shares in British supermarkets tumbling on Thursday.

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, which underscored how cash-strapped Britons have been cutting back spending on non-essential goods.

Its shares were down 12 percent to a 32-month low at 339.5 pence by 0830 GMT, wiping 3.7 billion pounds off its value.

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

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

Tesco, which lags only French group Carrefour and U.S. industry leader Wal-Mart by annual sales, said it expected minimal trading profit growth in the year to February 2013, compared with a market forecast for a 10 percent rise.

That followed a 2.3 percent drop in sales, excluding fuel and VAT sales tax, at British stores open a year in the six weeks to January 7.

It is not what I wanted for Christmas, said chief executive Phil Clarke, who pledged to fight back with millions of pounds of investment in price cuts and expanding online.

Tesco, which accounts for about one in ten pounds spent in British shops and makes over 70 percent of its trading profit in its home market, also said it would rein in openings of big hypermarkets as consumers cut back on big shopping trips.

This is a more than disappointing update from Tesco, said Shore Capital analyst Clive Black.

It amounts to a material profit warning for 2012/13 and we are downgrading not just our numbers but we are going to have to downgrade our recommendation too.

IT'S NOT GETTING BETTER

Clarke said Tesco's problems were partly due to weak consumer spending. The group sells a higher proportion of discretionary non-food goods like clothing and electricals than rival grocers like J Sainsbury and Wm Morrison, both of which reported small rises in underlying Christmas sales this week.

Other British retailers focused more on discretionary purchases reported even weaker sales on Thursday.

Home Retail, Britain's biggest household goods retailer, posted an 8.8 percent drop in underlying sales at its Argos stores and said it would cut its dividend, while Halfords and Mothercare also reported falling sales.

Clarke saw little respite for shoppers 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.

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

Tesco will cut more prices in the months ahead, he said, adding the group had also suffered from promotions and couponing by rivals. He questioned 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, adding this was partly due to heavy discounting.

Tesco, with over 5,300 stores in 14 countries, 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.

On Tuesday, Tesco said 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 which it is aiming to lift to break even by the end of its 2012/13 year.

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