* FTSEurofirst 300 down 7.93 points to 1,248.04
* Italian shares hit 2-year highs as Letta nears majority
* Tesco leads retailers lower after disappointing update
* Lufthansa slides after Deutsche cuts rating
By David Brett
LONDON, Oct 2 (Reuters) - Italy's FTSE MIB rose on Wednesday with Prime Minister Enrico Letta's growing chances of winning a confidence vote, outpacing broader European shares which were led lower by weakness in retailers after Tesco's results.
Italy's leading share index touched fresh two-year highs of 18,259.84 following defections from media tycoon Silvio Berlusconi's centre-right party that looked set to give Letta's government the votes it needs.
The index was up 0.9 percent at 18,143.78 at 1105 GMT, led by financial stocks. Lender Intesa San Paolo was up 4.3 percent and leading the gainers in Europe as Italy's bond yields eased.
Technical analysts were bullish on Italy's FTSE MIB with Chris Wright at Informa Global Markets saying the technical picture is constructive.
"The recent bounce from 17,199.82 (Sept. 30 low) confirmed a 3-month bull trendline ... Any near-term dips are seen to be supported by the bull trendline, currently at 17,284.36," he said.
Europe's FTSEurofirst 300, however, fell 7.93 points, 0.6 percent, to 1,248.04 by 1030 GMT, dragged lower by Tesco. The world's third largest retailer was down 3.6 percent after quarterly revenues flatlined as its turnaround plan failed to meet expectations, prompting earnings downgrades with implications for the wider market.
"There is very little valuation upside (for the broader market) without an earnings recovery ... so you are looking at slightly more downside risk than up if the earnings recovery does not materialise," Robert Quinn, chief European equity strategist at S&P Capital IQ, said.
Tesco's update took the shine off rival Sainsbury, which reported rising sales growth, and weighed on the broader retail sector, which fell 1.4 percent.
Food and beverage firms extended recent falls as the sector deals with the fallout of Unilever's shock profit warning late on Monday, with UBS the latest to cut its rating on the consumer goods firm to "neutral" from "buy".
Unilever was down 1.8 percent, and 9 percent down in the last 9 days.
Earnings worries also prompted falls in German airlines Lufthansa and Air Berlin, which fell by as much as 3.7 percent, after Deutsche Bank downgraded both stocks.
"We have ... come to the conclusion that the restructuring programmes might take longer than expected, the demand situation remains sluggish and current trading is difficult and capacity discipline is fading," Deutsche said, referring to both airlines.
The travel and leisure sector shed 0.9 percent.
Most global stock indexes kicked off a new month and a new quarter with gains on Tuesday as investors, for now, appeared confident that a U.S. government shutdown, which threw hundreds of thousands of federal employees out of work, would be short-lived, but concerns remained.
"If Congress do not come to an agreement and the deadline approaches for the U.S. to make interest payments on $12 trillion of outstanding bonds, traders will start to get twitchy," Mark Ward, head of trading at Sanlam Securities, said.
"But it is worth remembering a U.S. payment default is the absolute worst-case scenario. We are, however, reliant on politicians, so anything is possible," he said.
Against the backdrop of political turmoil in Italy and volatile market interest rates swayed by U.S. policy uncertainty, the European Central Bank was expected to hold off policy action on Wednesday but keep open the options of an interest rate cut or a bumper cash injection.