By Toni Clarke

WASHINGTON (Reuters) - The U.S. government proposed cutting nicotine in cigarettes to "non-addictive" levels on Friday in a major regulatory shift designed to move smokers toward potentially less harmful e-cigarettes.

Shares of major tobacco companies in the United States and UK slumped in heavy trading volume after the proposal was unveiled by the head of the U.S. Food and Drug Administration, with the world's biggest producers losing about $26 billion of market value.

"Nicotine itself is not responsible for the cancer, the lung disease and heart disease that kill hundreds of thousands of Americans each year," FDA Commissioner Scott Gottlieb said.

"It's the other chemical compounds in tobacco and in the smoke created by setting tobacco on fire that directly cause illness and death."

The FDA cannot reduce nicotine levels to zero, nor can it ban cigarettes. But Gottlieb said the agency would study regulating nicotine levels with a view toward the "FDA's potential to render cigarettes minimally addictive or non-addictive."

Analysts said they expect regulators in Europe to study similar actions on nicotine products.

The action shakes up a debate among public health advocates as to whether e-cigarettes represent a health risk or potential benefit.

"While there's still much research to be done on these products and the risks that they may pose, they may also present benefits that we must consider," Gottlieb said.

The FDA's announcement sets in motion a lengthy rule-making process that will involve public comment and input from multiple stakeholders before any measures take effect.

"It’s hard to overstate what this could mean for the companies affected: non-addictive levels of nicotine would likely mean a lot fewer smokers and of those people who do still light up, smoking a lot less," said Neil Wilson, a senior market analyst with ETX Capital in London.

Most big tobacco makers have long seen the writing on the wall and have invested in e-cigarettes and other alternative nicotine delivery systems, potentially mitigating the blow from any decline in cigarette sales.

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"We see this as an opportune entry point for long-term investors and would recommend building positions on today's broad weakness," Bonnie Herzog, an analyst at Wells Fargo Securities said in a research report, noting that the FDA is currently reviewing IQOS, a product from Altria Group Inc and Philip Morris International that heats tobacco instead of burning it.

For e-cigarettes, the agency extended the deadline by up to four years, and up to three years for cigar companies, to comply with a 2016 rule that gave the FDA oversight over the products, giving them more time on the market without regulation.

Matthew Myers, president of the Campaign for Tobacco-Free Kids, said the FDA's proposal "represents a bold and comprehensive vision with the potential to accelerate progress in reducing tobacco use and death."

But he added that the extension of e-cigarette deadlines "will allow egregious, kid-friendly e-cigarettes and cigars, in flavors like gummy bear, cherry crush and banana smash, to stay on the market with little public health oversight."

Gottlieb said the FDA would consider regulating "kid-appealing flavors" in e-cigarettes and cigars, and possibly banning menthol in all tobacco products.

British American Tobacco shares, trading close to all-time highs, fell 6.8 percent to post their biggest one-day loss in nine 9 years.

Altria, which makes the Marlboro brand of cigarettes, closed down 9.5 percent.

British American said it was not surprised by the FDA move to cut nicotine.

"Our American subsidiary, Reynolds American Inc. and its operating companies are encouraged by FDA Commissioner Dr. Scott Gottlieb’s comments today recognizing tobacco harm reduction policies and the continuum of risk for tobacco products," the company said in a statement.

Gottlieb also held out the possibility that premium cigars would be exempted from FDA oversight, but the overall outlook for traditional tobacco products appeared grim.

(Reporting by Toni Clarke and Ginger Gibson in Washington; additional reporting by Vikram Subhedar in London; editing by Chris Sanders and Tom Brown)