LONDON (Reuters) - Britain's services sector contracted at a slower pace than expected in August, but a gloomy consumer mood failed to improve and analysts still expect the economy to shrink and interest rates to fall.

Yesterday's figures came hot on the heels of news that manufacturing has contracted for four straight months, construction has declined for six months and a warning from finance minister Alistair Darling about the challenges ahead.

However, the closely-watched Chartered Institute of Purchasing and Supply/Market purchasing managers' index for services companies also provided a glimmer of hope that Britain could yet avoid a prolonged and deep slump.

The index actually picked up to 49.2 last month from 47.4 in July, a surprise outcome suggesting the sector, which makes up about three-quarters of the ecoonomy, hardly shrank at all.

Even so, the index for the sector that makes up about three-quarters of the economy has held below the 50 level marking the divide between contraction and growth since May.

"While there is some encouragement that the surveys have not weakened further this month, we still think it likely that the economy will contract in the second half of this year before recording negative growth in 2009 overall," said Jonathan Loynes, an economist at Capital Economics.

Sterling rose immediately after the data against the dollar and euro as the better-than-expected figures gave investors an excuse to buy back the currency after it was driven to fresh multi-year lows earlier in the session.

The pound has been hit hard by intensifying concerns about the state of the British economy. Sterling has slumped about 10 percent against the dollar in the last month and by a similar amount against the euro since the start of the year.

Investors are now convinced UK interest rates will fall, perhaps before Christmas, as Britain flirts with its first recession since the early 1990s.

The Organisation for Economic Cooperation and Development forecasts show Britain could enter that recession — two consecutive quarters of negative growth — this year.