Wal-Mart Stores Inc will dramatically increase its promotions over the next six weeks, a Morgan Stanley analyst said on Friday, calling it a major setback for U.S. grocers.

The shares of the Standard & Poor's Food Retail Sub-Industry Index fell 1.8 percent.

While this helps address Walmart's traffic woes, we view this as a major setback for the grocery stocks, which have been rallying on hopes of a return to more rational pricing, Morgan Stanley analyst Mark Wiltamuth wrote in a note.

Wiltamuth said the information on the promotions came from Chief Merchandising Officer John Fleming during a store tour and presentation. Wal-Mart could not immediately be reached for confirmation.

The world's largest retailer has used aggressive pricing in grocery and other units to bring shoppers into its stores. The grocery business is particularly pressured by such pricing, as its profit margins are already low.

Investors have been concerned about signs that shoppers who gravitated to Wal-Mart during the worst of the recession -- boosting sales and profits -- are returning to rivals. Wal-Mart's traffic fell in its U.S. stores during its fourth quarter, despite the holiday season when shopping is at its peak.

Wiltamuth wrote that Wal-Mart management said customers entering stores would be greeted by signs advertising price rollbacks on 10,000 items. The focus of the price cuts will be on food and other consumables, the analyst said.

The changes, to hit stores by April 1, will be supported by a television and media campaign, he said.

That timing means the campaign would be in place just before Easter, which falls on April 4 and is a big time for home-cooked meals.

Wiltamuth cited the continued strain on grocers margins and questioned whether the market should begin to ask whether grocers will be able to pass inflationary costs through to consumers.

Safeway Inc shares were down 2.4 percent at $24.05, while Supervalu Inc shares fell 2.5 percent to $16.71 in afternoon trading. Kroger Co shares fell 1.9 percent to $21.82 and Whole Foods Market Inc fell 1.3 percent to $35.54.

Wal-Mart shares were down 0.9 percent at $55.44.

(Reporting by Alexandria Sage; editing by Andre Grenon)

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