UPDATE 1-UK small business lending stagnant, construction contracts

* Construction PMI shows continued contraction in March

* BoE survey shows some lending up but small business weak

* Pressure on BoE and government to help smaller firms

By David Milliken

LONDON, April 3 (Reuters) - British small business lendingremained stagnant and the construction sector shrank again, datashowed on Wednesday, reinforcing a downbeat outlook for growthas the Bank of England holds its April policy meeting.

Boosting lending to smaller businesses is an important goalfor the government, while sharp falls in construction outputwere largely responsible for the economy shrinking in late 2011and early 2012, and threaten to tip Britain back into recession.

However the central bank has been sharply split for the lasttwo months over whether the right response is to restart its purchases of government bonds, or try other measures.

Wednesday's data is unlikely to shift the debate too far,but shows the challenges facing the Monetary Policy Committee.

Markit/CIPS construction PMI data turned out weaker thanexpected. The monthly survey of purchasing managers rose to 47.2in March from 46.8, suggesting the sector contracted again butnot as sharply as in February.

Markit, which compiles the survey, said unusually coldweather combined with sluggish demand kept a lid on constructionwork in March.

"It seems highly probable that the sector suffered renewedand appreciable contraction in the first quarter of 2013 afterall too rare expansion in the fourth quarter of 2012," saidHoward Archer, chief UK economist at IHS Global Insight.

A PMI survey for the service sector in March due out onThursday will give a clearer sign of whether Britain's economyas a whole avoided its third recession in less than five years,having already contracted in late 2012.

A separate survey by the Bank of England showed Britishbanks preferred to lend to home-buyers and big companies ratherthan small businesses during the past three months, and intendto do the same in the months to come.

The availability of mortgages and business loans moregenerally was forecast to expand, but at a slower pace thanearlier in the year, banks said.

More than five years on from the start of the financialcrisis, the distribution of bank lending is a politically andeconomically sensitive issue in Britain.

In the middle of last year the central bank and thegovernment launched a scheme to boost lending and reduceinterest costs, but it has had mixed success.

"A strong possibility is that the Funding for Lending Schemewill be adjusted to specifically favour banks that increasetheir lending to smaller companies," said Archer.

The banks surveyed by the BoE said small businesses' demandfor lending dropped sharply in the three months to early Marchand banks were wary of the more risky loan applications.

Banks expected demand from both small and large businessesto improve significantly over the next three months, however.

They also said the BoE's Funding for Lending Scheme hadreduced their borrowing costs and the premium they charged formortgages and for lending to both large and small companies.

This was the first fall in loan spreads for small businessessince the survey started in late 2009, though banks said theywere cutting rates for larger firms more sharply.