(Updates with meeting starting, prison camp, rise in killings)

By Ross Colvin

BAGHDAD, May 28 (Reuters) - U.S. and Iranian officials began rare talks in Baghdad on Monday to discuss Iraq's spiralling violence, which Washington says Tehran is fuelling by giving arms, funding and training to Shi'ite militias there.

Iran denies the charge, despite the U.S. military putting on display what it says are Iranian-made rockets, mortars and sophisticated roadside bombs seized in Iraq.

U.S. officials do not expect any great breakthrough from the talks, which come as U.S. warships hold war games in the Gulf and after Tehran said it had uncovered spy networks on its territory run by the United States and its allies.

U.S. President George W. Bush also called last week for stronger sanctions against Iran over its nuclear programme, which Washington says is being used to develop a nuclear bomb.

But the nuclear issue will not be up for discussion on Monday. Only one item will be on the agenda -- Iraq, where sectarian violence between minority Sunnis and majority Shi'ites threatens all-out civil war that could spill into the region.

The talks between U.S. ambassador Ryan Crocker and his Iranian counterpart Hassan Kazemi-Qomi mark a reversal by Washington, which broke ties with Tehran in 1980 and has largely sought to isolate the Islamic Republic in recent years.

Iraqi state television reported shortly after 10 a.m. (0600 GMT) that the meeting was under way.

Crocker has said he does not expect "any stunning, startling breakthroughs" from the meeting. U.S. officials say he will press Iran to take steps to reduce violence in Iraq.

"EFPS"

In the past few months, the U.S. military has displayed explosively formed penetrators (EFPs) -- a particularly deadly roadside bomb -- and other weapons it says are being supplied by Iran to Iraqi militants to target American soldiers.

The U.S. military also says Shi'ite militias are receiving funding and training in Iran. In February, U.S. troops detained five Iranians accused of ties to Iran's Revolutionary Guards, although Iran says they are diplomats.

The fate of the five could be one bargaining chip the Americans bring to the table, although Iran's Foreign Minister Manouchehr Mottaki said last week he had been assured by Iraqi Foreign Minister Hoshiyar Zebari they could be freed by June 21.

Bush, who initially rejected talks with Iran, is coming under growing domestic pressure to end the four-year-old war as U.S. casualties continue to mount.

At least 103 U.S. soldiers have died this month, just one short of the total in April, the worst month so far this year.

Bush has committed nearly 30,000 more troops to a major security crackdown in Baghdad aimed at curbing violence between majority Shi'ites and Sunnis Arabs. After three months of sharp declines, sectarian murders in the capital are on the rise, and Iraqi police reported finding 44 bodies on Sunday.

The crackdown has also forced many militants to move to areas outside the capital, where they have set up new bases, particularly in volatile Diyala province north of the capital.

The U.S. military said U.S. and Iraqi troops had raided a suspected al Qaeda prison camp in Diyala in an air and ground assault on Sunday and freed 41 men, some of whom had been held for four months.

Monday's talks follow a conference on Iraq in Egypt earlier this month, where a hoped-for meeting between U.S. Secretary of State Condoleezza Rice and Mottaki failed to materialise.

Despite the 27-year freeze in formal ties between Iran and the United States, mid-ranking officials from the two countries have met occasionally, most recently to discuss Afghanistan before and after the U.S.-led war to overthrow the Taliban.

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