The closely-watched Chartered Institute of Purchasing and Supply/Markit PMI index for the services sector, which makes up about three quarters of the economy, ticked higher to 47.4 last month from a seven-year low of 47.1 in June.

But that was the third consecutive reading below the 50 mark that divides expansion from contraction. Business confidence fell to its lowest since the CIPS survey began and employers made hefty cuts to their workforce.

Adding to the gloom, weaker than expected official data for industrial production suggested the initial estimate of second quarter GDP growth of 0.2 percent growth could be revised down.

"There’s no doubt that what is happening now is far more profound and will be more prolonged than people thought 12 months ago when this problem first arose," Chancellor Alistair Darling told BBC radio earlier on Tuesday.

The Treasury had just announced a further capital boost to Northern Rock -- the mortgage lender that crumbled at the height of the credit crunch and had to be rescued by the government.

TOUGH TASK

Further evidence that the economy is set for a turbulent period and possibly a recession -- two consecutive quarters of contraction -- will add to pressure on Prime Minister Gordon Brown who is struggling to keep his ruling Labour party in line.

Many voters, and some Labour politicians, have grown weary of Brown in his first year in office, in part because his reputation for economic competence has taken a tumble.

He now faces the tough task of having to win back support before the next election due by mid-2010 in the face of a restive party, soaring living costs and rising unemployment.

The Office for National Statistics said factory output unexpectedly fell 0.5 percent on the month, the fourth month of declines and the first time it has fallen consistently for that length of time since 2001.

The economy expanded 0.2 percent in the second quarter of this year, according to preliminary ONS data, but statisticians said June’s industrial output figures were "a downward drag" and would shave about 0.06 percentage point off the initial reading.

"There is a chance second quarter GDP (gross domestic product) could be revised down from an already weak pace of activity," said Philip Shaw, an economist at Investec.

However, sustained price pressures are likely to stay the Bank of England’s hand on interest rates on Thursday.

The services PMI survey showed cost inflation easing slightly but still notching its second highest reading on record.

The prices charged index was little changed at 55.9 from 56.0 and remains significantly higher than it was last year, showing companies were prepared or obliged to pass on some of their increasing costs to customers despite weakening demand.

(Additional reporting by Sumeet Desai and Adrian Croft; Editing by Ruth Pitchford)