UPDATE 1-Australia trade deficit blows out in August

(Adds market, analyst reaction)

* Trade deficit widens much more than expected to A$2.07 bln * Falling prices for iron ore and coal hit export earnings * Adds to case for further cuts in interest rates By Wayne Cole

SYDNEY, Oct 3 (Reuters) - Australia's trade deficit blew out to its widest in three-and-a-half years in August as falling prices for iron ore and coal ate into export earnings, just the latest sign of how China's slowdown is hurting the resource-rich country.

The Australian dollar skidded to a one-month low of $1.0226 from $1.0242 after Wednesday's data showed the deficit on goods and services yawned out to A$2.03 billion ($2.07 billion) in August, from a revised A$1.5 billion in July. That was far beyond forecasts of a A$700 million shortfall and the largest deficit since March 2008.

"It means the current account deficit will blow out in the quarter and the trend is clearly for further deterioration," said Su-Lin Ong, a senior economist at RBC Capital Markets.

"The fall is in prices rather than export volumes which shows the impact of weaker global growth and, of course, the slowdown in China," she added. "It will certainly keep pressure on for further cuts in interest rates."

The weakness in prices for key resource exports was one reason the Reserve Bank of Australia (RBA) cut its cash rate a quarter point to 3.25 percent on Tuesday. It is also why investors are banking on more easing.

Interbank futures put a 66 percent probability on a further move to 3.0 percent next month. Overnight indexed swaps , which show where the market thinks the cash rate will be over time, put rates down at 2.67 percent in 12 months.

Yields on Australian 10-year bonds are at 2.99 percent, so it costs less for the government to borrow for a decade than for banks to borrow overnight.

Prices for iron ore, Australia's biggest export earner, have steadied around $104 in recent days, up from a September low of 86.70. But that remains well under the $130-$150 range held for the first half of the year.

Since exports of the steel-making mineral had been running at over A$60 billion a year, such a fall if sustained would threaten to cut earnings by perhaps A$15 billion. That in turn would take a toll on mining profits, dividends, wages and government tax receipts.

The drag was clear in August with Australia's total exports falling 3.3 percent to A$24.6 billion, led by a 7 percent drop in metal ores and minerals and an 11 percent decline in coal exports.

Imports fell a smaller 1.3 percent, mainly due to a 13 percent drop in oil.

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Graphic of trade balance: Terms of trade: On global rates: ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (Editing by Eric Meijer)

((Wayne.Cole@thomsonreuters.com)(612 9373 1813)(Reuters Messaging: wayne.cole.thomsonreuters.com@reuters.net))