* Weak China factory activity weighs on steel demand outlook
* Iron ore hit a near four-week high, gains seen curbed
By Ruby Lian and Fayen Wong
SHANGHAI, June 20 (Reuters) - Shanghai steel futures dropped, from the three-week high hit in a previous session, after weak manufacturing data from China darkened the outlook for demand in the world's largest consumer and put pressure on the raw material iron ore.
The data which showed China's factory activity contracting to a nine-month low in June heightened risks that a second quarter slowdown could be sharper than expected, also adding to investor concerns that an increasing steel supply glut would keep a lid on prices.
"Investors remain concerned over the cooling economic growth as data suggested faltering demand, while sluggish activity in the physical market also dragged down futures, though the rally in iron ore has helped rebar against a rapid fall," said Xia Junyan, an analyst with Wanda Futures in Shanghai.
The most active rebar futures for October contract on the Shanghai Futures Exchange was down 0.3 percent to 3,488 yuan ($570) a tonne by midday break. It hit a three-week high of 3,530 yuan on Wednesday.
Steel output in China stands at record high levels as mills are keen to maintain market share despite declining margins, reversing the previous market expectation that mills would slash output to lift the market.
"Steel mills will face declining margins and are on the brink of making losses between May and June," Zhang Changfu, vice chairman of the China Iron & Steel Association said in a transcript published on the website.
Zhang expected that China's crude steel output to increase 6-8 percent in the first half from a year ago, as steel output is not likely to be slashed largely in June.
China produced a total of 301.19 million tonnes of crude steel in the first five months, up 8 percent from a year ago. This was much higher than an annual growth of 3 percent in 2012.
Spot iron ore prices surged to a near four-week high as traders push up the market by taking cargoes at rising costs.
Three similar deals for 62-percent Australian iron ore fines were sealed at $121 a tonne via the Singapore-based GlobalORE in late Wednesday, up more than one dollar compared with the previous deals.
"Chances are very high that some big traders are deliberately buying cargoes at such high prices in a bid to push up the market as real purchases from steel mills remains tepid," said an iron ore trader in Beijing.
"I would expect the current level to be the turning point given weak steel demand outlook."
Benchmark 62-percent grade iron ore index .IO62-CNI=SI stretched gains for a fifth straight day to $120 on Wednesday. up 2 percent or $2.3 from Tuesday and the highest level since May 27, according to information provider the Steel Index. ($1 = 6.1269 Chinese yuan) (Editing by Michael Perry)