* USDA widely expected to raise 2014/15 U.S. output outlook

* Hedge pressure, liquidation weigh on prices

* Exchange stocks fall from near one-year highs -ICE

NEW YORK, July 7 (Reuters) - ICE cotton fell to a two-year low on Monday on hedge pressure and bearish expectations that the government would raise its outlook for supplies in United States, the world's top exporter.

The benchmark December cotton contract on ICE Futures U.S. tumbled to the psychological support of 70 cents before ending down 1.85 cents, or 2.6 percent, at 70.21 cents a lb.

Selling began shortly after the market opened late, following the U.S. Fourth of July holiday on Friday, pushing futures to fresh lows as volumes picked up. It was the lowest for the third-month contract since July 2012.

The U.S. Agriculture Department is widely expected to raise its forecast for U.S. production at 15 million 480-lb bales when it updates projections for the 2014/15 crop year on Friday.

"The trade is under-hedged, given the size of the crop we are expecting. Now that the speculators have liquidated, they are in a bind," said Peter Egli, director of risk management for British-based merchant Plexus Cotton Ltd, referring to a sharp reduction in speculators' bullish stance in the most recent reporting week.

The outlook by traders for U.S. output has risen considerably in recent weeks with the arrival of rains in Texas, where a drought has crimped output in recent years.

Further, weekly U.S. government data showed speculators axed their bullish bet on cotton futures and options in the most recent reporting week.

Also, China's demand for imports was expected to fall sharply in the new crop year, beginning Aug. 1, as Beijing swaps its cotton stockpiling in favor of crop subsidies.

Exchange inventories fell sharply to 418,994 on Thursday from a near one-year high of 462,584 previously, the most recent ICE data showed on Monday. (Reporting by Chris Prentice; Editing by Jeffrey Benkoe)