* Baosteel raises July steel product prices more than 10 pct

* Under pressure to accept Rio's 33 pct iron ore price rise

* 38 small Chinese mills accept Rio's terms in deal with Vale (Adds comments, background, writes through)

SHANGHAI/SEOUL, June 10 - China's top steelmaker, Baosteel, has raised July prices for major steel product prices by more than 10 percent, industry sources said on Wednesday, as it faces the threat of higher-than-expected iron ore costs.

Baosteel, or Baoshan Iron and Steel Co Ltd, is deep in talks with Australian miners Rio Tinto and BHP Billiton over iron ore prices, which it wants reset to 2007 levels, meaning a price cut of at least 40 percent.

Rio Tinto has already agreed a 33 percent cut with other Asian mills, forcing Baosteel to choose between a fixed price, albeit more than it wanted to pay, or the uncertain spot market.

"It is testing waters. (Chinese) steel mills want to know whether their clients will accept the price rise if they concede a 33 percent price cut on the iron ore term," said a Beijing-based senior industry executive, who declined to be named because of the sensitivity of the subject.

Chinese spot market steel prices have been rising after hitting five-month lows in April as traders, encouraged by anecdotal evidence of end-user demand  recovery linked to China's massive economic stimulus plan, bet on further price rises.

But China's steel sector remains on a shaky footing. While Rio puts pressure on steel mills to swallow more iron ore costs than big mills such as Baosteel want to accept, export demand has collapsed and the outlook for China's own steel market, already plagued by overcapacity, remains murky.

SMALLER MILLS

Meanwhile the smaller mills have been pumping out more steel than last year and 38 of them have gone behind Baosteel's back to cut a 50 million tonne supply deal with Brazil's Vale, the world's largest iron ore miner, the Beijing News reported on Wednesday.

Two industry sources confirmed on Wednesday that the terms with Vale included prices that are equal to the deal the Rio Tinto and the Japanese steel mills have agreed.

None of the steel mills was state-owned, the newspaper said, and so are not members of the China Iron and Steel Association, the national industry group which has said its members would not conclude supply deals before price terms have been reached in protracted negotiations with Australian miners.

Analysts said the news might dampen the enthusiasm of the country's major steel mills to obtain a better price, while Chinese firms are focusing on their own profits rather than caring for the industry's overall interest.

"They are getting more realistic. They want to push the steel prices up, as rising spot prices of iron ore and coal have started to squeeze them," said analyst  Henry Liu at Macquarie Bank. 

Merrill Lynch this week upgraded its steel demand growth forecast in China for this year from 3 percent to 8 percent.

"China steel demand has been strong since February, with monthly consumption growing at 7-9 percent and destocking at mills and traders," it said in a note on Tuesday.

"We expect the strong demand momentum to last going forward. Property and auto sales are also likely to be robust throughout 2009 and into 2010. More steel demand from infrastructure is to come through the pipeline in the second half and 2010."

The prices posted by Baosteel, the listed unit of China's largest steel group, are considered the benchmark in China, the world's top steel producing and consuming country.

July prices for hot-rolled steel products will rise by 500 yuan ($73.17) per tonne, and prices for cold-rolled steel products will increase by 400 yuan per tonne, industry consultancy Umetal and two trade sources said.

Hot-rolled steel product prices will be 3,792 yuan a tonne for July, while cold-rolled steel product prices will be 4,226 yuan a tonne, according to Reuters calculations based on historical Baosteel price data. ($1=6.833 yuan)