UPDATE 1-Australia trade gap widens as commodity prices fall

* Trade deficit widens more than expected to A$556 mln

* Prices fall for coal and iron ore, with more to come

SYDNEY, July 2 - Australia's trade deficit doubled in May as a steep fall in the value of commodity exports overshadowed soft imports, likely just a taster of what's to come as swingeing price cuts for coal and iron ore feed through.

The local dollar dipped after the government reported the deficit on goods and services widened 97 percent to A$556 million ($448 million) in May, above forecasts of a A$125 million shortfall.

Exports fell 5.2 percent, with coal receipts down 15 percent due to cuts of 40 percent or more to contract prices for the country's single biggest export earner.

Prices for iron ore, Australia's second largest export, are in the process of being slashed right now as a slump in global trade eats into the demand for steel.

"The full brunt of the deepest and most synchronised post-war global recession has yet to fully bear down upon Australia," said Su-Lin Ong, a senior economist at RBC Capital Markets.

"Export income, the terms of trade, and business investment are all set to move substantially lower," she warned. "That's consistent with a continued easing bias for monetary policy."

The weakness of business spending was evident in the trade numbers, with imports of capital goods like machinery sliding 14 percent May and dragging total imports down by 3.8 percent.

The Reserve Bank of Australia (RBA) has already cut its key cash rate by 425 basis points to a record low of 3.0 percent, and has left the door open for further easing if necessary. Investors are generally pricing in only a modest probability of another cut, and certainly little chance of a move at the central bank's July policy meeting next week.

Yet with the trade account likely to weigh on growth for some months to come, any tightening in policy looked a distant prospect as well. "We are cautious that markets have moved too far and have been too quick to assume, and price, a v-shaped recovery," said Michael Blythe, chief economist at Commonwealth Bank.

"Relative to the market, we see more chance of a rate cut in the near-term and less chance of monetary tightening in the first half of 2010," he added.

CHINA RISK

The outlook for the trade account could be crucial as it was a huge swing to surplus in the first quarter of this year that saved the country from a technical recession.

Trade ended up contributing a huge 2.2 percentage points to economic growth in the quarter, keeping the economy afloat even as business investment sank. But trade was unlikely to add anything like as much in the second quarter and could prove a drag on growth going foward.

The country's terms of trade -- what it gets for exports compared to what it pays for imports -- are expected to fall around 20 percent this year, dealing a blow to profits, wages and tax receipts.

Much depened on China's appetite for commodities as it has been taking an ever larger share of Australia's resource exports in recent months.

"The risk is that China's stockpiling of Australia's key commodity exports may already have met an end, a key downside risk to the already fragile Aussie export outlook," said Helen Kevans, an economist at JPMorgan.