"it should work" is no good. You don't go buy an iPhone with the notion that it "should work". Why not simply call O2 about it? I'm sure they have some Call Center that'll have the info for you. Their website could help, too.
Basically:
Either they allow the use of pay&go cards in their iPhones on their network and activation in iTunes works – or they don't. It's not like you've found a secret passway that only works if you don't ask them. 
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