UPDATE 1-China lowers iron ore price cut demand-reports

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SHANGHAI, July 1 (Reuters) - China has softened its demands for a large iron ore price cut after failing to agree terms with global miners by Tuesday's deadline, Chinese media reported, the first sign of a possible compromise meant to restore annual supply deals and avoid a total breakdown of the benchmark system.

Citing officials attending a closed meeting of the China Iron and Steel Association (CISA) on Tuesday, Caijing magazine and the official Shanghai Securities News said China was still expecting a better deal than the 33 percent reduction agreed by Rio Tinto with Japanese steel mills, but offered an olive branch.

China is now ready to discuss a smaller price cut of 33-40 percent rather than its previous demand of a 40-45 percent reduction and hopes to end talks quickly, the Shanghai newspaper quoted a source close to the situation as saying.

No substantive discussions between CISA and the three global miners -- Rio Tinto (RIO.AX) (RIO.L) and BHP Billiton (BHP.AX) of Australia and Brazil's Vale (VALE5.SA) -- had taken place over the last two weeks, Caijing reported.

Rio Tinto has shown no inclination to go lower than the one-third price cut, saying it is ready to sell to its customers on whatever basis they prefer.

Spot iron ore prices to China have risen by a fifth in just a month, and now trade at a 4-month high above $80 a tonne on a delivered China basis, equivalent to around $65 free on board. This is higher than the contract price of $61 that the Japanese and South Korean mills secured, giving miners the upper hand.

"By abandoning the benchmark price... Chinese mills run the risk that if the spot price rallies further, they could end up paying higher prices than the rest of the world," Macquarie analysts said on Wednesday in a report.

"The fact that spot and new benchmark prices have converged already must be a source of concern for the Chinese given that European, Japanese, Korean and Taiwanese import demand remains extremely depressed."

In another development, some domestic big steel mills have tacitly reached agreements with miners and issued letters of credit to buy iron ore at the price accepted by Japanese mills, the official China Securities Journal citing industry sources as saying.

Small Chinese mills, eager to fix production costs and prepare for demand upturn, had already signed private deals, ignoring threats from CISA that it would not recognise the deals and revoke import licenses. (Reporting by David Stanway and Alfred Cang; Editing by Michael Urquhart)