The firm, which trails troubled market leader Tesco and Wal-Mart Stores' Asda by sales, said it remained cautious about prospects for its full financial year with food price deflation and intense competition likely to continue.

It said sales excluding fuel at stores open more than a year fell 1.7 percent in the 14 weeks to Jan. 3, its fiscal third quarter, an improvement after a second-quarter drop of 2.8 percent. Analysts' had forecast a 2.5-4.4 percent sales fall in the third quarter.

Analysts welcomed the performance but noted Sainsbury's remained vulnerable to a fight back by Tesco under new boss Dave Lewis, and from discounters Aldi and Lidl which have won market share by offering products at a low price with fewer ranges.

Shares in the 145-year-old company, down 36 percent during the last year, rose 4 percent while Tesco and fourth-placed player Morrisons rose 3 percent.

"Sainsbury's numbers were better than expected but I am not a buyer of the stock for now, as top line guidance remains unchanged," said Securequity sales trader Jawaid Afsar.

Sainsbury's had outperformed rivals for years, thanks to a strategy focused on own-brand products and the quality of its food, while expanding its convenience and online businesses. But it too has been hurt by the rise of the German discounters which looks set to spark a prolonged price war.

"Given the uncertainty in the trading environment, food price deflation and the price reductions we announced this week, we currently expect our fourth quarter like-for-like to be similar to that of our first half (down 2.1 percent)," it said.

Sainsbury's said in November it would cut costs, dividends and plans to open new stores to spend another 150 million pounds on lowering prices.
This week, Sainsbury's lowered prices on more than 700 products, including its meat, fish and poultry categories.

Asda said on Tuesday it was investing 300 million pounds in the first quarter of 2015 to cut prices on essential items and branded products. That cost is part of the 1 billion pounds the grocer said in November 2013 it would spend over five years.

Tesco is also expected to try to defend market leadership with further price reductions. It will give an update on trading and strategy on Thursday.
Analysts do not expect any of Britain's other so called "big four" grocers to post like-for-like sales increases over the Christmas period.

$1 = 0.6605 pounds