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UK supermarkets caught in dangerous middle ground

The full extent of the problems facing the U.K.'s "big four" supermarket chains was underlined on Thursday, with a profit warning by WM Morrison sending shares in the sector sharply lower.

The country's fourth biggest grocer, WM Morrison, which holds 11 percent of market share, saw its shares plunge around 8 percent after posting its lowest profit in five years. It also slashed its forecast for 2014.

Contagion in the sector led to shares of Tesco - the biggest U.K. supermarket by market share - losing 4.5 percent. J Sainsbury fell 7.2 percent.

(Read more: UK grocer Morrisons slashes profit expectations)

Analysts heaped criticism on WM Morrison, saying its strategy had become muddled -- it both hopes to return to its heritage as a "value retailer," but is also trudging on with expensive online and convenience projects.

This may be indicative of an underlying trend that analysts said other chains also faced, that of a lack of direction in the middle-ground between budget and high-end retailers.

In decades gone by, Tesco and its peers rose to prominence with only themselves as competition. This landscape has radically changed, however, with new entrants at both the higher- and lower-end.

Waitrose, an employee-owned retailer, rose out of near-obscurity in the early 2000s and now continues to post record earnings with its top-of-the-range offerings and "upmarket" reputation. Meanwhile, at the lower-end, German retailers Aldi and Lidl have eaten away at the big-four's market share, because of their success at targeting budget conscious customers.

(Read more: Sainsbury's Justin King steps down, shares drop)

Simon Dawson | Bloomberg | Getty Images

This means WM Morrison and the like are "stuck between a rock and a hard place," according to Rahul Sharma, founder and managing director at Neev Capital.

"Something bad is happening with groceries," he told CNBC Thursday, warning investors away from the sector.

He said shoppers still had the wages to spend, but have realized that they could do a "full shop" in budget supermarkets like Aldi and Lidl.

"I think the whole space is struggling," he said. "People are going for conveniences, they don't like the temptation that the big stores offer. And frankly the big stores have become lazy on price."

(Read more: Tesco admits to wasting huge amount of food)

Sharma added that even the large U.S. chains, like Walmart, were not immune to these trends, predicting a structural fall on investor returns.

Chris Beauchamp, a market analyst at IG Markets, told CNBC that middle-ground supermarkets needed to work out where they want to go from here.

"Perhaps we have seen the heyday for the supermarket," he said. "The scrap in the middle is going to be the most interesting thing."

Beauchamp added that Sainsbury could be best placed for a rebound in consumer spending after the economic downturn, with its more "middle class" offering.

By CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81.

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