Tesco steps up challenge to rivals with new price cuts

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* Q1 UK underlying sales up 2.1 pct

* Prices reduced on fresh food

* CEO silent on Sainsbury (Amsterdam: SJ6.AS - news) 's/Asda deal

* Trading update published ahead of shareholders' meeting

* Shares (Berlin: DI6.BE - news) rise as much as 3 pct

By James Davey and Kate Holton

LONDON, June 15 (Reuters) - Tesco (Frankfurt: 852647 - news) said a new drive to cut food prices boosted quarterly sales, turning up the heat on rivals three years after Britain's biggest retailer started work on a turnaround plan.

Shares in Tesco rose as much as 3 percent after the group also said it was delighted with initial progress at wholesaler Booker, which it acquired in March, and was on track to deliver its medium-term financial targets.

Tesco, forced to rebuild after a 2014 accounting scandal capped a dramatic downturn in trading, said a move to lower prices on fresh food brands towards the end of its first quarter reflected a growing confidence in its performance.

"It's about us continuing to invest in the offer," Chief (Taiwan OTC: 3345.TWO - news) Executive Dave Lewis told reporters, noting that prices in core lines had already been lowered by 6-7 percent over the previous three years.

The strong performance is timely as Tesco faces increased competition in a sector already reshaped by inroads made by German-owned discounters Lidl and Aldi.

Accustomed to being the biggest beast in the industry, Sainsbury's proposed 7.3 billion pound ($9.7 billion) takeover of Walmart's Asda would push Tesco down into second place.

The lower prices, plus a relaunch of 10,000 own-brand products, helped Tesco to counter bad weather in March and deliver underlying sales growth in its home market of 2.1 percent in its first quarter to May 26. That was at the top end of analysts' forecasts and a 10th consecutive quarter of growth.

"To have slowed down only slightly from (2.3 percent in the previous quarter) is a good achievement given lower levels of inflation in the market, tougher (comparatives) and generally unhelpful weather in the quarter," said analysts at Barclays (LSE: BARC.L - news) who have an "overweight" stance on the stock.

SILENT ON SAINSBURY'S/ASDA

The lower prices will be welcomed by British consumers where a string of retailers have struggled in a tough market.

The rise of Aldi and Lidl and the growing popularity of online sales has forced traditional groups Tesco, Sainsbury's , Walmart's Asda and Morrisons to rethink their strategies.

Lewis's boldest move was to buy Booker for 4 billion pounds ($5.3 billion) to expand into supplying restaurants, cafes and local shops.

Tesco currently dominates Britain's supermarket sector by a clear margin, with a 27.7 percent market share, according to industry data. However, a Sainsbury's/Asda combination would top that.

Lewis declined to comment on the takeover, merely stating that Tesco would submit its views to the competition regulator in due course.

Booker's like-for-like sales rose 14.3 percent, including tobacco, partly reflecting new business wins.

As a group, underlying sales growth was 1.8 percent, its strongest quarterly performance since 2011.

"Our growth plans are on track and we are pleased with the momentum in the business," said Lewis, who joined Tesco in 2014 shortly before the accounting scandal was uncovered.

Prior to Friday's update analysts were on average forecasting a group operating profit before exceptional items for the 2018-19 year of 2.092 billion pounds, up from 1.644 billion pounds in 2017-18, according to Reuters data.

Analysts point out that earnings scenarios in Tesco's latest management long term incentive plan (LTIP) to 2021 are much higher than consensus expectations.

Tesco's trading update was published ahead of its annual shareholders' meeting later on Friday, where Lewis could face some flak over his near 5 million pounds 2017-18 pay package, labelled "excessive" by shareholder advisory group Pirc. ($1 = 0.7557 pounds)

(Editing by Guy Faulconbridge/Keith Weir)