* Australia cuts 2016, 2017 iron ore price forecasts

* Says demand growth slowing

* Sees price averaging $44.20/T in 2016

* Could lead to higher national budget deficit (Adds more comment, Treasury figures, details)

By James Regan

SYDNEY, July 8 (Reuters) - Australia on Friday signalled it sees the current rally in iron ore prices coming to an end, cutting its price forecasts over the next 18 months to reflect an industry grappling with oversupply and weak demand. The Department of Industry, Innovation and Science cut its 2016 forecast for the country’s biggest export earner by nearly 2 percent to an average of $44.20 a tonne and by 20 percent to $44 in 2017.

Australia, the world’s largest exporter of iron ore - forecast to total 818 million tonnes this year - warned the steel-making ingredient will be slower to recover in 2017 than previously expected due to oversupply.

The department previously forecast 2016 prices to average $45 a tonne in March and earlier predicted 2017 prices to average $55.

“Despite the large movements in prices, the market fundamentals are broadly unchanged - demand growth is slow and the market remains well supplied,” Australia’s Department of Industry, Innovation and Science said in its latest quarterly commodities paper.

Iron ore .IO62-CNI=SI was trading at $55.20 a tonne, according to the latest quote from The Steel Index. Iron ore averaged $48 in the first six months of 2016.

The official forecast is also short of the Australian Treasury’s $55 per tonne prediction contained in the national budget released in May.

The Treasury forecast represented a 41 percent increase on its December view of $39 and took into account a spike in ore prices to almost $70 in April.

A price closer the Department of Industry calculation would increase the projected national budget deficit for 2016-17 of A$37.1 billion ($27.82 billion) by roughly A$1.5 billion.

Morgan Stanley recently lifted its 2016 iron ore forecast by 17 percent to $46 a tonne and its 2017 outlook by 13 percent to $42.

Dragging on sentiment are hefty stocks of imported iron ore sitting at major Chinese ports. Inventories stood at 102.55 million tonnes on July 1, the highest since December 2014, according to data tracked by SteelHome SH-TOT-IRONINV.

Global iron ore trade is forecast to grow by 0.9 percent and 4.0 percent in 2016 and 2017, respectively, despite relatively flat global consumption, according to the industry department.

This will occur because imports will displace iron ore mined in China, it said. ($1 = 1.3335 Australian dollars) (Reporting by James Regan; Editing by Christian Schmollinger)