According to early reports, the world champion had led his home rally after SS2, but an engine problem forced him to retire on the following Pays d'Ormont stage.
Loeb's championship lead over Mikko Hirvonen had already been reduced to 15 points after the Frenchman crashed in Australia, making today's problem another threat to his title bid - although Hirvonen lost time on SS3 with a quick trip off the road and is now 56.6 seconds off the lead.
Sebastien Ogier leads the event in the remaining works Citroen, ahead of Petter Solberg in the Solberg Citroen.
Finn Kimi Raikkonen has also retired, after crashing his Citroen on the way to SS3, while warming up his tyres!
The Minis of Dani Sordo and Kris Meeke are also showing strong form.
Jari-Matti Latvala also went off on SS3 in the second Ford, losing just over a minute.
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