UPDATE 2-European shares fall, scorched by China rare earth warning

European shares slid on Wednesday as Chinese newspapers warned it could squeeze its supply of rare earth elements to hit the United States, sending jitters through the markets and prompting investors to flee for safer ground. While China has so far not explicitly said it would restrict the sales, Chinese media strongly implied this will happen, in a move that would escalate tensions between the world's two largest economies.

Rare earth elements' uses include rechargeable batteries for electric and hybrid cars, computers, wind turbines and lighting. The pan-European STOXX 600 index tumbled 1.4% to a more than three-month closing low, with each sub-sector falling.

"Trade tensions have certainty gone up a notch, and investors are running for the hills," David Madden, market analyst at CMC Markets UK, wrote in a note. "European markets have also to contend with the rising political tensions between Italy the EU ... investors fear the political fight could trigger a debt and banking crisis in Italy."

Italian equities shed 1.3% on the day. The country's banks have been under pressure this week, during which time yields on the Italian sovereign's debt have broadly risen against the backdrop of a possible 3 billion euro fine on Italy by the European Commission for breaking EU rules. Frankfurt's trade-sensitive DAX fell 1.6% to its lowest close in nearly two months. Data showed German unemployment rose unexpectedly in May for the first time in nearly two years, in a sign that a slowdown in the euro zone's top economy is spilling over into the labour market.

French stocks shed 1.7%, while their London-traded peers fell 1.2%. Technology stocks fell 2.2%, underperforming most other STOXX 600 sub-indexes. The sector would be more exposed than most to any supply squeeze of rare earths from China, which is home to most reserves.

Oil and gas stocks dropped 1.7%, with wind turbine maker Vestas Wind Systems sliding 4.2%. The retailers sub-index posted the steepest losses on the STOXX 600, with Casino Group falling 4% after the indebted French supermarket cancelled its interim dividend and suffered a new credit ratings downgrade.

Market researcher Kantar said Britain's "Big Four" supermarkets all lost market share in the 12 weeks to May 19, sending Tesco shares 5.2% lower, while those of Sainsbury's dipped 0.2%. Basic resources stocks shed 2%, with ArcelorMittal diving 4.2% as the world's top steel maker announced plans to cut its output in Europe.

Athens-traded stocks dipped 0.2% but held near a more than one-year closing peak clocked on Tuesday. (Reporting by Aaron Saldanha in Bengaluru, Graphic by Helen Reid in London; Editing by Alison Williams)