UPDATE 1-Moody's cuts Fiat on weak Italian sales

* Cuts Fiat ratings by one notch to Ba3

* Says could cut further on negative net cash flow

* Shares down 1 pct, underperform sector

MILAN, Oct 10 (Reuters) - U.S. credit agency Moody's cut its rating on Italy's Fiat to Ba3 with outlook negative on Wednesday, citing the carmaker's reliance on its declining home market.

"The one-notch downgrade of Fiat's ratings to Ba3 reflects the decline in demand for Italian cars recorded so far this year and in our outlook for demand till the end of 2012 and beyond," Falk Frey, a Moody's Senior Vice President and lead analyst for Fiat said in a statement.

Moody's said it would consider downgrading Fiat further if standalone net industrial cash flow were to exceed a negative 2 billion euros in 2012 and not improve in 2013.

Fiat bondholders do not have full access to Chrysler cashflow, the rating agency said, adding it does not forsee a major change in this access over short time.

"This leads Moody's to expect further deterioration in Fiat's standalone credit metrics in 2012, with limited improvement likely in 2013," Frey said.

Chrysler exited government-funded bankruptcy protection in 2009 under the management control of Italian automaker Fiat, which was also given a 20 percent stake in the U.S. automaker.

Since its bankruptcy, Chrysler has become Fiat's main source of strength as auto demand in Europe contracts. The combined Fiat-Chrysler group now makes more than two-thirds of its profits in the United States.

Moody's warned about the impact of overcapacity in Italy, the challenging target of reaching a break-even point in trading profits in EMEA by 2014 and the absence of any major new volume model launch which could hurt competitiveness in Europe.

Moody's said it expected demand for light vehicle in western Europe to decline by 8 percent this year and a further 3 percent in 2013. The European passenger car market accounts for over 60 percent of Fiat revenues excluding U.S. carmaker Chrysler.

The agency also estimates demand in Italy to fall by 20 percent this year and to stabilise next year.

Sergio Marchionne, chief executive of both Fiat and Chrysler Group LLC, will revise 2-year growth plans for both automakers later this month to reflect the slump in European auto sales since 2009.

Fiat shares were down 1.1 percent at 4.23 euros by 0715 GMT, underperforming a slightly negative European car sector .

(Reporting by Antonella Ciancio; Editing by David Cowell)

((Antonella.Ciancio@thomsonreuters.com)(+39 0266129722)(Reuters Messaging: antonella.ciancio.thomsonreuters.com@reuters.net))