* UK Q3 like-for-like sales down 7.1 percent
* To cut around 1,230 store and head office jobs
* Targets 200 million pounds of cost savings
* Shares close 2.2 percent higher
(Adds Rose salary details, closing shares)
By James Davey and Mark Potter
LONDON, Jan 7 (Reuters) - British retailer Marks & Spencer reported its biggest fall in sales for a decade but a plan to cut up to 200 million pounds ($298 million) of costs, including 1,230 jobs, raised hopes it could protect profits and dividends.
Shares in Britain's biggest clothing retailer, which had dropped two thirds in value over the past 20 months and underperformed the DJ Stoxx European retail index by 50 percent last year, rose as much as 8.4 percent on Wednesday.
They closed up 2.2 percent higher at 244 pence.
Executive Chairman Stuart Rose said he expected challenging economic conditions to continue for at least the next 12 months.
"Every company has to cut its cloth according to its means and we are just making sure that ... our company is well placed to deal with what will be an incredibly difficult year," he told reporters.
A spokeswoman said Rose did not intend to take a pay rise this year and did not expect a bonus.
The 125-year-old clothing, food and homewares group said like-for-like sales in Britain fell 7.1 percent year-on-year in the 13 weeks to Dec. 27, its third quarter. It was the biggest fall in sales since 1999.
Forecasts were for a fall ranging from 5.5 to 9.6 percent, according to a company poll of nine analysts.
The news from M&S, which serves more than 21 million Britons a week from over 600 stores, will add to the gloom surrounding the economy as the Bank of England starts its monthly policy meeting.
M&S said it expected its UK gross profit margin for the year to March 31 to be about 1.75 percentage points below 2007-08 due to promotions and discounts, worse than its previous guidance for a fall of around 1 point.
It said it was managing costs tightly and now expected operating cost growth for the current financial year to be towards the lower end of its forecast range of 4 to 5 percent.
Operating costs for next year would be about 1-2 percent below 2008-09 levels, equivalent to a reduction of about 175 to 200 million pounds, it said. This would represent a fall in the group's underlying cost base of about 7 percent.
The savings would be delivered in part by closing 27 stores, including 25 from its Simply Food format, with the loss of about 780 jobs, and by cutting up to 450 head office staff.
M&S employs around 75,000 people worldwide.
Shop workers union Usdaw said it was shocked by the job losses. "We want to know the business case for this decision and are seeking to meet with the company to have urgent meaningful consultation," National Officer John Gorle said.
But retail analysts took a different view.
"The cost initiatives are to be applauded," said KBC analyst John Stevenson. But he expected analysts' consensus profit forecast for 2008-09 to fall from about 620 million pounds towards his estimate of 595 million and for earnings to remain under pressure in M&S's next financial year.
"With the pressure on gross margin we've got, and given the sales outlook, we still expect profits to be falling next year."
Philip Dorgan, analyst at Panmure Gordon, also welcomed the cuts, saying the cost reductions were "much, much bigger than we have ever seen before and give the company a huge war chest to survive current difficult conditions and means it will emerge from the recession as a highly geared play on the consumer.
"Noises on the dividend are encouraging, and we may yet be wrong in forecasting a cut," he said.
M&S finance director Ian Dyson told reporters there was no change in group dividend policy "at this stage". Dyson also said M&S, which had net debt of 3.1 billion pounds at the end of September, did not have an issue with banking covenants.
M&S's like-for-like general merchandise sales, which include clothing and homewares, were down 8.9 percent in Britain, while food sales on the same basis were down 5.2 percent, it said.
Rose dismissed the suggestion that M&S's poor Christmas threatened his own position. "If this was an aeroplane flying through a storm I don't think the best thing to do is nip up the front and chuck the pilot out," he said.
For a factbox on how Britain's retailers fared over Christmas click on. (Editing by Dan Lalor and Elaine Hardcastle)