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* Manufacturing set to contribute to UK recovery in Q2
* New orders rise at fastest pace in over two years
* Banks using BoE lending scheme cut credit by 300 mln stg
By David Milliken and Christina Fincher
LONDON, June 3 (Reuters - A strong rise in new orders helpedBritish manufacturing grow at its fastest pace in over a yearlast month, a survey showed on Monday, and revised data forApril meant UK factories have now had a two-month expansion.
Weak lending data from the Bank of England, however,highlighted the ongoing challenges facing the economy.
Banks and building societies taking advantage of the Bank'sFunding for Lending Scheme cut lending by 300 million pounds($455 million) in the first three months of the year, leavingthe central bank hoping for a pick-up later in 2013.
But economists said the strong manufacturing data made itincreasingly unlikely that policymakers would return to theirprevious approach of large-scale bond purchases, either at BoEGovernor Mervyn King's last rate-setting meeting this week oronce Mark Carney succeeds him on July 1.
The Markit/CIPS Purchasing Managers' Index rose to a14-month high of 51.3 in May, and April's figure was revised upto above the 50-mark that divides growth from contraction.
"This reduces the likelihood of more quantitative easing, atleast in the immediate term. I think this is part of a positivetrend," said George Buckley, UK economist at Deutsche Bank.
Factory output contracted 0.3 percent in the first threemonths of 2013 and has been a drag on growth for much of thepast year, but May's figures offered a positive outlook, withorders rising at their fastest pace in more than two years.
"Signs that the manufacturing sector is recovering will addfurther weight to the Bank of England's decision to wait and seebefore adding to its accommodative policy stance," said Markiteconomist Rob Dobson.
The Bank of England is widely expected to refrain fromaction at its June policy meeting on Thursday, and a Reuterspoll last week showed that economists believed the chance ofmore asset purchases this year had fallen below 50 percent.
Britain's economy grew by 0.3 percent in the first threemonths of 2013 - stronger than most economists expected - butthe recovery is fragile and there is an ongoing political debateabout how far it is hampered by government austerity measures.
In a speech hosted by Thomson Reuters earlier on Monday, theopposition Labour Party's finance spokesman, Ed Balls, said itwould have to cut some welfare benefits if it returns to powerafter an election in 2015.
LACKLUSTRE LENDING
The central bank bought large sums of government bondsbetween March 2009 and October 2012, but has more recentlyfocused on measures such as the Funding for Lending Scheme toboost the flow of credit to households and businesses.
However, figures on Monday showed that banks and buildingsocieties taking part in the scheme had reduced lending by some1.79 billion pounds since July last year, despite drawing down16.45 billion pounds from the scheme.
The figures are broadly consistent with Friday's BoE datafor the banking sector as a whole in April.
Most of the fall in lending is due to three of the country's largest lenders - Santander and state-controlled RoyalBank of Scotland and Lloyds Banking Group -cutting net lending by billions of pounds as they run downexcessive loans made before the financial crisis.
Barclays and the mutually-owned Nationwide BuildingSociety increased lending by the most.
Last month the FLS was changed to give banks a greaterincentive to lend to small businesses, and Paul Fisher, the BoEpolicymaker in charge of the scheme, said he expected thesituation to improve later in the year.
"The plans of the FLS participants suggest that net lendingvolumes will pick up gradually through the remainder of 2013,"he said.
