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UPDATE 4-Japan, South Korea raise the stakes in dispute over forced labour

Takaya Yamaguchi and Hyunjoo Jin

* Japan could widen curbs, minister says

* Moves could hit S.Korea tech giants Samsung, SK Hynix

* Seoul rebuts Japan media reports of chemical transfer to N.Korea

* Seoul dispatched official to Washington

* Move came weeks before Japan election (Recasts)

TOKYO/SEOUL, July 9 (Reuters) - Japan and South Korea raised the stakes on Tuesday in a diplomatic dispute that threatens to disrupt global supplies of smartphones and chips, with South Korea denouncing Japanese reports that it had transferred a key chemical to North Korea.

At the root of the dispute between the U.S. allies is compensation for South Koreans forced to work for Japanese firms during World War Two.

It worsened last week when Japan said it would tighten curbs on exports of three materials crucial for advanced consumer electronics because trust with South Korea had been broken over the forced labour dispute.

The restrictions on exports of the material to South Korea could hit tech giants, such as Samsung Electronics and SK Hynix, which supply chips to the likes of Apple and Huawei.

It also underscores Japan's grip on a vital link in the global supply chain that Prime Minister Shinzo Abe's government is using as leverage days before a parliamentary election.

In some of the sharpest comments yet, South Korean Industry Minister Sung Yun-mo urged Japan to "stop making groundless claims immediately", an apparent response to a Japanese media report last week.

Media quoted an unidentified senior member of Abe's ruling Liberal Democratic Party (LDP) as saying some hydrogen fluoride exported to South Korea had ultimately been shipped to North Korea.

Hydrogen fluoride, a chemical covered by the Japanese export curbs, can be used in chemical weapons. Japan has said it has seen "inappropriate instances" of South Korea's export controls, but has not elaborated.

Asked about countermeasures, Sung said South Korea was reviewing "every possible plan", but gave no details. The neighbours plan to hold talks on Friday, he added.

BITTER HISTORY

The dispute stems from Japan's frustration over what it sees as South Korea's failure to act in response to a ruling by one of its courts last October ordering Japan's Nippon Steel to compensate former forced labourers.

Japan says the issue of forced labour was fully settled in 1965 when the neighbours restored diplomatic ties.

The neighbours share a bitter history dating to Japan's colonisation of the Korean peninsula from 1910 to 1945, which saw forced use of labour by Japanese companies and the use of comfort women, a Japanese euphemism for girls and women, many of them Korean, forced to work in its wartime brothels.

Politicians from both sides have at times over the years factored the lingering ill-will into their calculations.

The export curbs come weeks ahead of a July 21 upper house election that Abe's Liberal Democratic Party (LDP) and its junior partner are expected to win with a solid majority.

"Unfortunately, the election is coming," said one person familiar with the Japanese government's thinking. "The LDP will do anything to solidify their support base."

Lee Young-chae, a professor at Keisen University in Tokyo, also said politics seemed to be a factor.

"One issue that could lead to an election win seems to be rallying Abe's conservatives and consolidating swing voters by showing an anti-South Korea, a tough stance toward South Korea," Lee said.

"And it seems to be working."

'WHITE LIST'

Japan on Tuesday raised the possibility of more measures against South Korea.

"Whether Japan implements additional measures depends on South Korea's response," Industry Minister Hiroshige Seko told a news conference.

Japan was "not thinking at all" of withdrawing the curbs, which did not violate World Trade Organization rules, he said.

South Korea, meanwhile, would raise the issue at a meeting of WTO member nations on Tuesday and with U.S. officials in Washington, South Korean officials said.

President Moon Jae-in has said South Korea could not rule out countermeasures for damage to its firms. He is due to meet executives from top conglomerates on Wednesday.

Japan threatened last week to drop South Korea from a "white list" of countries with minimum trade restrictions, hitting supplies of a wider range of items used in weapons production.

Japan's halt of preferential treatment for the three materials used in consumer electronics forces exporters to seek permission for each individual shipment to South Korea, which takes about 90 days. (Reporting by Takaya Yamaguchi, Kaori Kaneko, Chris Gallagher, Makiko Yamazaki in TOKYO and Hyunjoo Jin, Hyonhee Shin, Ju-min Park, Joyce Lee and Jane Chung in SEOUL Writing by David Dolan Editing by Clarence Fernandez, Robert Birsel)