By Saif Hameed

BAGHDAD (Reuters) - The United Nations appealed on Sunday for $861 million to help Iraq meet a big funding gap in its 2016 emergency response to the humanitarian crisis caused by the war against Islamic State.

Baghdad, whose revenues have fallen as oil prices have plunged, has said it would manage to finance less than half of its $1.56 billion plan to assist 10 million people in need.

"With the expanding needs, the allocation through the federal budget will not be sufficient. We expect that the highly prioritized (U.N.) Humanitarian Response Plan will help cover part of the gap," Minister of Migration and Displacement Jassim Mohammed al-Jaff said in a statement.

U.N. humanitarian coordinator in Iraq Lise Grande said she expected the crisis in Iraq "to widen and worsen" in coming months.

The United Nations expects huge numbers of civilians to flee Mosul when Iraqi forces mount an offensive to retake the northern city from Islamic State, which the authorities have pledged to do this year.

"The number of people who need help is going up, the amount of resources is going down and that's why you have a really big gap. What we're trying to do in a very clear way is to prioritize," she told Reuters after launching the appeal in Baghdad.

Among the 10 million Iraqis requiring urgent assistance are more than 3.3 million people displaced by the conflict with Islamic State since 2014 and a quarter million people from neighboring Syria who have fled from their country's nearly five-year-old war, according to the United Nations. Children make up half of the displaced population.

The Iraqi government allocated around $850 million last year for efforts to shelter such families and help them return to recaptured areas, but it ended up funding less than 60 percent of that, according to a government report.

The U.N. plan said it was only asking for a fraction of the $4.5 billion deemed necessary to meet humanitarian needs in an acknowledgment of security and funding constraints on its operations.

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"The amount being requested is not commensurate with the overall humanitarian needs in Iraq... (but) accurately reflects the absolute minimum required to help Iraqis survive the crisis," the plan said.

Islamic State seized about a third of Iraq's territory in the north and west in 2014, but has slowly been pushed back by Iraqi forces, Iranian-backed Shi'ite militias and Kurdish peshmerga fighters - backed by U.S.-led coalition air strikes.

Most of the displaced people, living in makeshift camps, disused buildings and homes in Baghdad, the northern Kurdistan region and other areas, are from Iraq's Sunni minority.

Jaff said he expected 200,000 families could return home this year.

(Reporting by Saif Hameed, Writing by Stephen Kalin,; Editing by Angus MacSwan)