Been offered a free iPhone as an upgrade on my current contract with O2.

However, not sure I'm going to get on with a 'touch screen' being a heavy texter on normal handsets for so long.

If I get it but don't like it, can I stick my existing Sim back in my old phone (Nokia N73) but then buy a Pay&Go Sim only, stick £10 on it and put that in the iPhone and effectively use it like an iPod Touch?

(ie turn off all connectivity but use it for music only?)

The answer to your first question is yes, you can use your iPhone SIM in any unlocked phone.

As for the second question, I am not entirely sure. I am not sure whether a standard O2 PAYG SIM would work in the iPhone, but I don't see why not. If so then you can shut off features like Data Roaming and Automatic email checking to stop it using any credit. Thereby being able to use the iPod + Wi-Fi just as you would with an iPod Touch.

All this is assuming you don't get a long with the iPhone though. I think you will be surprised and find yourself using your iPhone as your main phone.