Well, I KNOW it's weird for you. But she's had the talk now and is trying it out. I remember I immediately started masturbating after I found out all about the birds and the bees (I found out alot at about 9 because I was curious and read alot.) because I was just totally curious about the whole thing. She could've been fantasizing with the pillow.
She's getting to the age where she's going to have hormonal urges. I would definitely talk to her about abstinance from real sex. I don't believe in actually TALKING about or explaining masturbation with your kids (unless they ask, I suppose, then you keep it simple! it just totally freaked me out when my parents did!) but expect them to do it and don't make a big deal out of it. Pretend like you believe her if she's caught and makes up something cause she's embarrassed. But yeah, I think it's all 100% normal fantasy/curiosity and I wouldn't freak out about it.
I'm only 23 myself, and remember those days clearly. I have a toddler who I can't imagine having to deal with the sex stuff with!!!
It's so weird when it's your own kid, and you can never admit to yourself that they are actually old enough for that!!!!