LONDON (Reuters) - Britain fell deeper into recession than first thought in the first quarter of this year after a sharp drop in construction output, raising the likelihood the Bank of England will need to inject more stimulus to protect the economy from the raging euro zone debt crisis.

Britain is in its second recession since the 2007-2008 financial crisis, and the prospects for a recovery are cloudy as leaders in the euro zone, Britain's biggest trading partner, are still far from resolving their debt woes.

The Bank of England has indicated it is ready to pump more money into the economy, having paused its 325 billion pound quantitative easing programme earlier this month, amid growing worries about a break-up of the currency union.

"The economy is not recovering properly and with the uncertainty over Europe hanging over the outlook as well, our suspicion is the MPC will sanction further QE at some point later on this year," said Philip Shaw, economist at Investec.

The Office for National Statistics said the economy shrank by 0.3 percent in the first quarter of this year, a downward revision from an initial estimate of a 0.2 percent decline, and confounding analysts' forecasts for an unchanged reading.

Year-on-year, the economy contracted by 0.1 percent, the first annual decline since Q4 2009.

The figures will make uncomfortable reading for British finance minister George Osborne, who has vowed to press ahead with harsh austerity measures to curb Britain's debts and has argued that the private sector can fill the gap in public spending.

Britain's economy has expanded by just 0.3 percent since the Conservative/Liberal Democrat government came to power in 2010, and Thursday's figures showed government spending made the biggest contribution to the economy between January and March.

DOWNWARD REVISION

The ONS said the downward revision to the Q1 data was the result of a sharp drop in construction output, which fell by 4.8 percent on the quarter, its steepest decline since Q1 2009.

New data on expenditure suggested the decline in overall GDP would have been steeper were it not for a 1.6 percent quarterly rise in government spending, which was the biggest increase in four years and contributed 0.4 percentage points to GDP.

Household spending, meanwhile, rose by only 0.1 percent, its smallest rise in six months and suggesting that a consumer-led recovery is not on the cards.

The figures showed that exports also suffered. The trade deficit increased to 4.4 billion pounds, with net trade shaving off 0.1 percentage point from GDP.

But separate preliminary data showed business investment posted its biggest quarterly rise in almost a year, and its largest annual increase in almost seven years.

The International Monetary Fund this week warned about the risks facing Britain and urged policymakers to boost growth by whatever means necessary.

It suggested the BoE could cut rates further from their record-low 0.5 percent and start buying private-sector assets.

And it recommended that the government should find money to invest in infrastructure and do more to boost the flow of credit to companies. The IMF said Britain may even need to consider a temporary tax cut to bolster demand.

Although the BoE is concerned that official data might be understating the strength of the economy, recent surveys have indicated that activity is tailing off, while an extra public holiday in June is also likely to depress growth in the second quarter.

In a further sign of weakness in the economy, figures published by the British Bankers' Association showed net mortgage lending rose by 715 million pounds in April, around half the increase recorded a year ago, though the number of mortgage approvals was up slightly on the year.

(Reporting by Fiona Shaikh and Olesya Dmitracova)

UK recession deepens as euro zone woes mount