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UPDATE 2-Brazil to raise taxes, freeze spending to meet target -sources

(Recasts with size of budget freeze)

BRASILIA, July 20 (Reuters) - Brazil's government will increase this year's spending freeze and raise taxes to cover a budget gap, two sources told Reuters on Thursday, reinforcing its commitment to fiscal discipline but dealing a potential blow to fragile economic growth.

The government will freeze an additional 5 billion reais ($1.60 billion) in federal spending this year and raise fuel taxes to collect 11 billion reais in extra revenues, said the sources, who requested anonymity because the measures had yet to be publicly announced.

Brazil lost its investment-grade rating in 2015 after missing its budget targets for years.

The country's renewed austerity effort has weighed on public investments in infrastructure and disrupted services such as passport issuance, but has been justified by President Michel Temer's year-long administration as a necessary step to rebuild trust with investors.

Officials had previously said they planned to reduce the spending freeze, currently at 39 billion reais, as tax revenues were expected to increase.

Finance Minister Henrique Meirelles on Wednesday said in an interview to GloboNews TV that the budget restrictions were reaching excessive levels and could be reduced within 60 days.

Brazil targets a budget deficit of 139 billion reais this year before interest payments. The deficit in the 12 months through May reached 167.6 billion reais, equivalent to 2.59 percent of gross domestic product.

The measures are expected to be announced later on Thursday, ahead of the July 22 deadline for a bimonthly budget revision.

The tax hike will be implemented by executive decree and will not need endorsement by Congress -- bypassing lawmakers' strong opposition to tax increases in the recession-hit economy ahead of an election year.

Brazil's economy is expected to grow 0.3 percent in 2017 after contracting by more than 3 percent in each of the past two years, according to a weekly central bank poll of economists.

The Finance Ministry declined to comment.

($1 = 3.1309 reais) (Additional reporting by Lisandra Paraguassu; Writing by Silvio Cascione; Editing by Bernard Orr and Sandra Maler)