CHICAGO (Reuters) - A surge in surplus US corn supplies due to sluggish demand from an ailing ethanol sector and the economic turmoil portends weaker prices, but could provide some relief to the food and livestock industry.

The US Agriculture Department took traders and analysts by surprise on Thursday by reducing the amount of corn to be used by the ethanol industry by 300 million bushels, to 3.7 billion, in the 2008/09 marketing year that began September 1.

The forecast came at a time when US corn prices have tumbled from a record high $7.65 a bushel set in June to $3.41, slumping 55 percent.

"We knew (corn) demand was sinking. This took a knife to the balance (sheet) table. This puts an anchor on the corn market," said Don Roose, analyst, US Commodities.

US corn export sales in the current marketing year are down 48 percent from last year amid the availability of cheap wheat that is being used to feed livestock.

The lower prices for corn could, however, provide some relief to meat companies that suffered when prices surged.

"Longer term I would say this report is friendly for livestock and poultry feeders. Just because of more abundant supplies and less upside potential (on prices)," Doug Harper, analyst at Brock Associates, said of the USDA corn data.

"It will now take a more significant (crop) production problem to send prices sharply higher."

Corn is the foundation for the US ethanol industry and four billion bushels, or roughly a third of the total corn crop of 12 billion bushels, had previously been penciled in by the USDA to be used by ethanol makers.

Now, the USDA says, only 3.7 billion bushels will be converted to ethanol, down 7.5 percent but still nearly 25 percent more than the amount of corn converted to ethanol fuel this past year.

"It was a surprise. No one expected them to cut ethanol usage by 300 million bushels," a trader said.

USDA also trimmed 100 million bushels of corn from its previous estimate for US corn exports.

The government now says the supply of corn at the end of next year in the US will reach nearly 1.5 billion bushels, up 30 percent from the 1.124 billion bushels forecast in November and nearly as high as the 1.624-billion-bushel surplus at the end of this year.

Livestock and poultry growers are hoping that the bigger stockpile of corn will help keep a lid on feed costs after stumbling through 2008 due to sharply higher corn and soybean meal prices.

"If they had kept carryover down near 1.1 billion then we probably would have needed close to 90 million acres of corn. The way it is now, we could probably get by with almost unchanged acreage," Harper said.

US farmers planted about 86 million acres of their land to corn this year, according to the USDA.