hi
i dont know were the key is to it
but the watery cave itself is en the town above the inn
you wil see a closed little gate if you press A to open FInn wil say its locked

You get the key from Paolo, but first go to the inn (after meeting the Wizard) and talk to
Colleen, Jake, and Yolanda. They'll all tell you about the lighthouse and meeting Paolo.
So head down that way and when you talk to the little kid inside (Paolo), he'll talk to
you about the Watery Cave. Select to ask about the lighthouse first, and then the bell
next. Then he'll give you the key to open up the cave.
Hope that helps.

cave ihs behindd a locked oranqeee qatee like abovee dhaa hotel && ihf yhuu qo tew dhaa
liqhthousee && tawk Tew dis lil boii ask hym abouhh dha keyy && he will qiv iht tew yhuu !
:) hopee i cud helpp ! && ihf i cudnt ohhh welppsss ! :P