Devastating drought in Russia and neighboring countries has reduced world wheat harvest prospects more than expected, a U.S. government report showed on Thursday, threatening to renew a blistering price rally that has revived memories of 2008.

While world wheat stocks will remain well above crisis levels seen in 2007/08, the Agriculture Department cut its world wheat production forecast by 2.3 percent to 645.73 million tonnes in its August report, its first estimate since Russia, normally the world's No 3 wheat exporter, banned shipments to conserve domestic stocks.

The trade will open higher, but then realize that we are still actually above average for the world wheat. We have gone from excessively bloated stocks to above normal, said Rich Nelson, analyst with Allendale Inc.

But on soybeans and corn, traders were split over whether the market would focus on the USDA's record high yield estimates -- bigger upgrades than had been expected in its first report based on field surveys -- or the fact that robust export demand forced it to cut back ending stocks forecast.

An unexpectedly large batch of weekly sales data, including an unusual wheat sale to Canada, underscored the potential for a bullish response when Chicago markets open.

The news was expected to buoy Chicago wheat futures, although traders said data for corn and soybeans was bearish.

Traders had anticipated a world wheat estimate of 650 million tonnes.

This is the third month in a row that USDA has lowered its forecast for world wheat supplies, taking its estimate down a total of 4 percent since May and lowering its projection for ending stocks by 12 percent or 23 million tonnes since May.

Stocks are 40 percent or 49.9 million tonnes higher than in 2007/08 when prices soared to record levels, the USDA said.

Weeks of unrelenting heat forced Moscow to halt wheat exports for the rest of this year, sending prices to a two-year high last week. The drought is also ravaging Ukraine and Kazakhstan and raised fears of a global food crisis like 2007-08 when prices soared and tens of millions of people were unable to buy enough to eat.

The USDA aggressively cut Russia's crop to 45 million tonnes, down 15 percent from its previous estimate, and reduced Kazakhstan by 18 percent to 11.5 million tonnes and Ukraine by 15 percent to 17 million tonnes.

It slashed Russian exports by 80 percent to a mere 3 million tonnes, factoring in Moscow's ban on exports.

Ahead of the report, some traders had believed the USDA's report would not fully reflect the damage from Russia's worst drought on record, but the USDA's estimate was in line with Russian analyst SovEcon, which had pegged the crop at 43.5 million tonnes.

US CROPS LARGER THAN EXPECTED

But U.S. crops will help fill the gap, the USDA said, pegging production at record levels and beyond what traders had expected.

Farmers are poised to harvest a record 13.365 billion bushels corn, above trade estimates of 13.279 billion bushels. The soybean crop was pegged at 3.433 billion bushels, 2.3 percent higher than trade estimates. Yields for both crops also topped average trade projections.

Crop problems in Russia and elsewhere will boost demand for U.S. wheat, the USDA said, cutting estimates of ending stocks.

U.S. wheat exports were forecast for 1.2 billion bushels, up 20 percent from the July estimate and the largest in three years. Wheat ending stocks were forecast at 952 million bushels, 1 percent less than traders had forecast, but still would be the largest in 11 years.

U.S. corn and soy ending stocks for the current 2009/10 crop year, which ends August 31, were cut by more than expected. Corn end stocks were estimated at 1.426 billion bushels, 3 percent less than trade forecasts, and soybeans 160 million, 5 percent below trade estimates.

For 2010/11, corn ending stocks were estimated at 1.312 billion bushels, slightly above trade estimates, and soybeans 360,000 million bushels, above trade estimates of 319,000 million.

(Additional reporting by Jasmin Melvin and Ayesha Rascoe in Washington and Bob Burgdorfer in Chicago; Editing by Russell Blinch, Jonathan Leff and Jim Marshall)

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