* U.N. watchdog sets up team to handle Iran investigation
* May be attempt to strengthen focus on Iran's nuclear activity
* IAEA report to show enrichment centrifuge expansion - diplomats
* Iran denies nuclear weapons aims
By Fredrik Dahl
VIENNA, Aug 29 (Reuters) - The U.N. nuclear watchdog is establishing a specialised team to inspect and investigate Iran's nuclear programme, which diplomats say is expanding despite tough Western sanctions and the threat of an Israeli attack.
The U.N. agency announced the establishment of an Iran Task Force shortly before it is expected to issue a report showing that the Islamic state has installed more than 300 new uranium enrichment machines in a fortified underground facility.
Its latest report on Iran's nuclear work, due to be released on Thursday or Friday, also is likely to highlight deep concern about suspected efforts to remove any evidence of illicit atomic activity at an Iranian military complex, diplomats say.
The statement on concentrating the agency's Iran experts in a dedicated team, seen by Reuters, was made separately to staff on Wednesday. Previously, the Iran dossier was handled by a department that also was responsible for other countries.
The findings in the upcoming International Atomic Energy Agency (IAEA) report on Iran's nuclear programme may strengthen the Israeli belief that diplomatic and economic pressure is failing to make Iran curb its disputed atomic activities.
Bellicose rhetoric from some Israeli politicians has fanned speculation that Israel might hit Iran's nuclear sites before the November U.S. presidential vote. Washington has said there is still time for diplomatic pressure to work, but it could be drawn into any war between the two Middle East foes.
Iran denies allegations it seeks a nuclear weapons capability and says all its atom work is for peaceful purposes.
The IAEA report "will be seized upon by those who argue that Israel can't afford to wait before taking unilateral military action to stop Iran", said Mark Fitzpatrick of the International Institute for Strategic Studies in London.
Diplomats say the IAEA is expected to say that Iran has completed installation of two additional cascades - linked networks of 174 enrichment centrifuges each - at the Fordow site buried deep in a mountain, since its previous report in May.
While the new machines are not yet operating, the move reaffirmed Iranian defiance of international demands to suspend enrichment, which can have both civilian and military uses depending on refinement level.
The IAEA and Iran failed on Friday to strike a deal aimed at allaying concerns about Tehran's nuclear programme by unblocking an agency probe into suspected nuclear weapons research.
Iran's refusal to limit and open up its atomic activity to unfettered IAEA inspections that could determine whether it is purely peaceful, or not, has led to harsher punitive sanctions and increased talk about possible military action.
Citing satellite images, diplomats say Iran has been "sanitising" a military facility, Parchin, where the IAEA believes it has carried out explosives tests relevant for nuclear weapons development.
"Iran is in the final stages of cleansing the site," one Western envoy said, casting doubt on whether IAEA inspectors would find anything even if they were allowed to go there.
Iran says Parchin, southeast of the capital Tehran, is a conventional military facility and has dismissed the allegations about it as "childish."
An IAEA report showing that Iran has not cooperated in resolving outstanding issues and has added centrifuges at Fordow would "heighten Israel's already acute concern the IAEA can't assure the world that Iran's nuclear program is peaceful," said Mark Hibbs of the Carnegie Endowment for International Peace.
The IAEA's decision to form a Task Force on the Islamic state appeared to be an attempt to focus and streamline its handling of the sensitive file by setting up one single unit with Iran experts and other resources it already has.
The brief IAEA statement to staff said the Iran Task Force would be part of the agency's department of safeguards, which carries out inspections around the world to make sure nuclear material is not diverted for military purposes.
The move underlined that the IAEA is prioritising its Iran investigation. "The agency had the resources and people in place and now they are trying to make sure the appropriate structure is there to continue to support them," a Western diplomat said.