(Recasts with court decision)

By Jeffrey Heller

JERUSALEM, May 20 (Reuters) - Israeli Prime Minister Ehud Olmert lost his first court challenge on Tuesday against a bribery investigation that could force him from office.

The Supreme Court, rejecting Olmert's petition, cleared the way for a lower court to hear preliminary testimony from a U.S. businessman who prosecutors said handed the veteran politician cash-filled envelopes before he became prime minister.

Before the three-justice panel announced its decision, police said they planned to question Olmert for a second time, on Friday.

Olmert has denied any wrongdoing but said he would resign if indicted in the corruption investigation, a move that could trigger an early election in Israel and likely disrupt U.S.-brokered peace talks with the Palestinians.

Police, who first questioned Olmert on May 2, have said he is suspected of taking "significant sums of money from a foreigner or a number of foreign individuals over an extended period of time".

Prosecutors can now summon businessman Morris Talansky to a Jerusalem District Court to provide testimony in the case, before the New York resident, who is currently visiting Israel, returns to the United States next week.

Israel Radio said Talansky would appear in the district court on Sunday.

Olmert's attorneys had tried to persuade the Supreme Court that such testimony, at an early stage of the investigation, would impinge on Olmert's right to a fair trial by effectively indicting him before any formal charges were brought.

In its ruling, the Supreme Court said it "saw no reason" to overturn the lower court's decision to hear Talansky's testimony, noting that as a result prosecutors would be obliged to disclose to Olmert's attorneys evidence gathered so far.

Olmert acknowledged earlier this month that Talansky raised funds for his two successful campaigns for mayor of Jerusalem in 1993 and 1998, a failed bid to lead the right-wing Likud party in 1999 and a further internal Likud election in 2002.

Israeli law broadly prohibits political donations of more than a few hundred dollars.

Olmert has said his former law partner handled the details, voicing confidence the attorney made sure proper procedures were followed. A judicial source said the sums involved totalled hundreds of thousands of dollars. (Editing by Matthew Jones)

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