* Report in line with expectations, drags prices lower

* Traders seen 'buying the rumor, selling the fact' - broker

* USDA ups forecast for record world inventories

NEW YORK, April 9 (Reuters) - Cotton futures sank on Wednesday as investors booked profits after the U.S. government cut its outlook for U.S. supplies in line with expectations.

The most-active May cotton contract on ICE Futures U.S. closed down 1.35 cents, or 1.5 percent, to settle at 90.44 cents a lb after hitting a two-week low of 90.31 cents.

The U.S. Agriculture Department (USDA) cut its forecast for 2013/14 supplies by end-July in the United States, the world's top exporter, to 2.5 million 480-lb bales due to lower output.

The forecast for inventories to plunge to their lowest in over two decades was widely anticipated after a March ginnings report indicated U.S. output was below previous forecasts.

Fiber prices surged on Tuesday on expectations of the bullish USDA report and were choppy ahead of its noon publication on Wednesday.

"It's a case of buying the rumor, selling the fact," said Jobe Moss, a broker with MCM Inc in Lubbock, Texas.

The index fund roll added to the pressure on nearby contracts and contributed to another day of above-average volumes, traders said.

The report held no surprises and was a "nonevent," said Sharon Johnson, a cotton specialist with KCG Futures in Georgia.

The USDA again raised its outlook for record world inventories by the end of July, increasing it slightly to 96.9 million bales.

That increase will reinforce concerns over excess global supplies as stocks in China, the world's top consumer, balloon due to a government stockpiling policy.

Beijing is overhauling the controversial program it launched in 2011 that has driven voracious import demand and kept a floor under world prices. (Reporting by Chris Prentice; Editing by Richard Chang)