By Aleksandar Vasovic and Gleb Garanich

VUHLEHIRSK/KRAMATORSK, Ukraine (Reuters) - Rockets killed more than 10 civilians and soldiers deep in Ukrainian government-held territory on Tuesday and rebels pushed on with an assault on an army-held rail junction, setbacks that showed Kiev's position worsening on the eve of peace talks.

Advances by pro-Russian rebels diminished hopes of a deal when Russia, Ukraine, France and Germany hold a summit in Belarus on Wednesday under a new Franco-German initiative to halt fighting in a war that has killed more than 5,000 people.

Representatives of the "Contact Group" meeting in Belarus on the Ukraine crisis denied a report by Russia's TASS news agency that a ceasefire deal had been reached in talks in Minsk. Rebel representative Denis Pushilin told Russian channel Rossiya24 it was too early to talk of any agreements and said the sides were taking a break.

European officials say it is difficult to imagine the rebels agreeing to halt and go back to earlier positions after weeks during which they have been advancing relentlessly.

A Russian source quoted by the state RIA news agency said there were no plans to sign a document to resolve the conflict at the peace talks, and the main subject would be creation of a demilitarized zone.

The war and years of endemic corruption have nearly bankrupted Ukraine, where the currency collapsed last week. Ukraine is negotiating a rescue package with the International Monetary Fund and sources said that could be expanded dramatically to provide as much as $40 billion in aid.

The White House said U.S. President Barack Obama urged Russian President Vladimir Putin in a phone call on Tuesday to agree to a peace deal.

"If Russia continues its aggressive actions in Ukraine, including by sending troops, weapons, and financing to support the separatists, the costs for Russia will rise," the White House statement added.

The Kremlin, in its statement about the call, said Putin and Obama highlighted the need for the need for a political solution to the "internal" conflict in Ukraine.

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The Kremlin also said the two leaders also noted the necessity to safeguard the rights of inhabitants of all Ukrainian regions, including Russian-speakers in the east.

TRIUMPHANT REBELS

Rockets crashed into Kramatorsk, some 50 km (30 miles) north of the front, hitting the main headquarters of the Ukrainian military campaign in the east, as well as nearby residential areas. Local officials said at least seven civilians were killed, while 26 civilians and 10 soldiers were wounded. A parliamentary deputy said four soldiers were also killed.

A Reuters photographer saw the body of a woman who had been killed, laid out in light snow where she fell. The tail of a rocket stuck out of a small crater in the ground.

The rebels denied firing on the town, but their apparent ability to strike so far into Ukrainian-held territory will complicate the peace talks that aim to reestablish a ceasefire that the separatists repudiated with a new offensive last month.

At the front in Vuhlehirsk, a small town captured by rebels last week, volleys of artillery crashed in both directions. The rebels are pushing to encircle government forces holding out in nearby Debaltseve, a rail hub that is the main rebel target.

Rebels sounded triumphant and said they had no intention of halting with government troops on the back foot.

"The Debaltseve bubble has been shut firmly. We will not let them out. There is no way they can get out," said a commander of a reconnaissance unit who identified himself by the nom de guerre of Malysh - "Little One".

Asked about a ceasefire, Malysh, who said he was a Russian fighter and not a Ukrainian, replied: "We are absolutely against it. They will have time to regroup. We have them now."

The Kremlin, which the West accuses of sending arms, weapons and soldiers across the frontier to help fight for territory it calls "New Russia", announced month-long war games on Tuesday involving about 2,000 troops on its side of the border. Russia denies involvement in the fighting in Ukraine.

Paris and Berlin have kept expectations low for their new peace initiative. French President Francois Hollande said the leaders were heading to the talks "with the strong will to succeed, but without being sure that we will be able to do it".

German Foreign Minister Frank-Walter Steinmeier said simply holding the summit was no guarantee of success and that nothing had been resolved yet.

Ukrainian President Petro Poroshenko said Wednesday's talks would be one of the last chances to declare an unconditional ceasefire and withdraw heavy weaponry, proposals that appear to have more appeal to retreating Kiev than to advancing rebels.

The renewed fighting has brought calls in the West for more pressure against Moscow. Obama is weighing whether to deliver weapons to Kiev.

He met German Chancellor Angela Merkel on Monday but announced no decision on weapons, despite several senior officials in his administration coming out last week in favour of sending some arms. European countries oppose sending arms to Kiev, arguing that would escalate the war while providing nowhere near enough fire power for the Ukrainians to win it.

COUNTER-OFFENSIVE

Kiev announced on Tuesday its forces launched a counter-offensive in the southeast to relieve separatist pressure on the port of Mariupol, the biggest city in the rebellious provinces still in government hands. Details could not be confirmed, but it is unlikely to provide much relief on the main battle front where government forces have been steadily pushed back.

On the outskirts of Vuhlehirsk, a rebel reconnaissance unit was busy securing trenches and bunkers that had been abandoned by Ukrainian troops. They scavenged weapons, ammunition, wires for field telephones and even discarded boots, sleeping bags and mats. An armoured rebel column of tanks and trucks approached the newly captured town.

Seven Ukrainian soldiers had been killed and 23 wounded in the past 24 hours, military spokesman Anatoly Stelmakh said before the rocket strike on Kramatorsk.

(Additional reporting by Pavel Polityuk, Richard Balmforth, Gabriela Baczynska, Andrei Makhovsky and Yekaterina Golubkova, and Alessandra Prentice in Kiev, Andrei Makhovsky in Minsk, and Jeff Mason and Roberta Rampton in Washington; Writing by Peter Graff; Editing by Sophie Walker, David Stamp, Peter Cooney and Grant McCool)