* China factory activity rises for first time in 9 months
* Spot iron ore set for biggest weekly fall this year
* Volatile iron ore throws shaky lifeline to small miners (Adds small miners boosting Chinese shipments, updates prices)
By Manolo Serapio Jr
MANILA, April 1 (Reuters) - Shanghai steel futures rallied more than 3 percent on Friday after data showed that activity in the country's vast factory sector has expanded for the first time in nine months.
However, slow buying activity in China's physical iron ore market has weighed on spot prices, with the steelmaking raw material on course for its biggest weekly drop this year.
China's manufacturing activity unexpectedly expanded in March for the first time in nine months, an official survey showed, adding to hopes that downward pressure on the world's second-largest economy is easing. see signs of recovery, more than stabilization, in China's economy after seasonal weakness in February. This came faster than our expectation," said Argonaut Securities analyst Helen Lau.
That could boost the outlook for steel demand in the world's top consumer, which showed signs of strength this year, as Shanghai steel futures scaled a nine-month high last week.
Rebar, a construction steel product, closed up 3.4 percent at 2,193 yuan ($339) a tonne on the Shanghai Futures Exchange SRBcv1 .
On the Dalian Commodity Exchange, September iron ore DCIOcv1 rose 2.1 percent to 386.50 yuan a tonne.
Appetite for physical iron ore cargoes was slow this week in China, pulling prices down 16 percent from their peak in March.
"The seaborne iron ore price continued to decline in the absence of any concrete policy measures by the Chinese government," ANZ Bank said in a note.
"However, the recent rebound in prices raises the risk of other high cost supply remaining in the market."
Iron ore for immediate delivery to China's Tianjin port .IO62-CNI=SI was flat at $53.20 a tonne on Thursday, according to The Steel Index. It was down 4.1 percent for the week so far.
The spot benchmark has fallen from a near nine-month peak of $63.30 reached on March 8, but still ended the first quarter with a gain of 24 percent.
That made iron ore the top performing commodity, far outpacing gold, which logged its best quarter since 1986.
A surprise spike in iron ore prices is shaking out fresh supplies of the raw material, but some miners say it is too soon to aggressively restart production shuttered by a years-long price rout.
Iran said it has increased shipments to China, while traders have also seen more cargoes from India and Malaysia as material kept idled in warehouses and ports is pushed out to buyers to take advantage of the price spurt. ($1 = 6.4639 Chinese yuan)