* UK GDP shrinks faster than previously thought in Q3
* First economic contraction since 1992
* Productivity drops for first time since 1989, mortgage approvals slump
(Adds detail, context)
By Fiona Shaikh and Matt Falloon
LONDON, Dec 23 (Reuters) - Britain edged closer to recession in the third quarter of this year, with the economy contracting by more than previously thought and at its sharpest rate since the early 1990s, according to official data on Tuesday.
The Office for National Statistics said gross domestic product shrank by 0.6 percent in the three months to September, revised down from a previous estimate for a 0.5 percent decline.
That was the biggest fall since 1990 and worse than analysts' forecasts for an unrevised figure.
And analysts reckon there is worse to come after separate figures showed output by British workers fell for the first time in nearly 20 years in Q3, while output in the services sector, which accounts for nearly 75 percent of the whole economy, continued to shrink in the three months to October.
"It really does paint an exceptionally gloomy picture about the speed with which the UK economy has lapsed into recession," said Matthew Sharratt, economist at Bank of America.
"The decline we are likely to see in the fourth quarter and first quarter (2009) will be substantially worse than what we have seen in Q3."
Policymakers have stepped up measures to prevent a recession -- two consecutive quarters of contraction -- in Britain from becoming a depression as soaring unemployment, a tumbling housing market and tight credit have hit hard.
The Bank of England has slashed borrowing costs by 3 percentage points since October and is likely to deliver further big cuts from the current 2 percent rate in the new year.
The government's 20 billion pound stimulus package, meanwhile, which includes a temporary cut in sales tax, has been dismissed by some experts as being too minor to make any difference.
"Temporarily cutting VAT ... does not seem to me to be a good idea -- 2 percent less is not perceived by consumers as a real incentive to spend," the International Monetary Fund's chief economist Olivier Blancherd was quoted as saying on Tuesday.
LOOMING RECESSION
Policymakers are agreed that the credit crunch is driving Britain into its first recession since the early 1990s.
Economists in a Reuters poll estimate the economy will contract by 1.6 percent next year, far worse than government forecasts for a 0.75-1.25 percent decline.
And Tuesday's figures fuelled speculation that the Bank of England may eventually have to resort to extraordinary measures, such as boosting money supply, to help shore up the economy.
"There remains significant downside risks to GDP in the UK. In particular, the adjustment of the saving ratio, business investment and inventories are all far from over," said David Owen, economist at Dresdner Kleinwort.
The ONS said the downward revision to the third-quarter data was due to bigger than previously estimated falls in manufacturing output and weaker services output.
The manufacturing sector shrank 1.6 percent on the quarter, the biggest fall since 2001 and the distribution, hotels and catering sector contracted 2.1 percent on the quarter, its biggest fall since 1980.
The services sector posted its biggest fall since 1990 as business services and finance output shrank 0.6 percent, reversing growth of 0.5 percent in the second quarter.
Moreover, consumers chose to put more money aside in the third quarter, with the household saving ratio rising to 1.8 percent from 1.1 percent in Q2.
And separate figures from the British Bankers' Association showed approvals for home loans fell to just 17,773, down 61 percent on the year.
"The data supports our view of the BoE cutting the Bank Rate to 0.5 percent, where it will probably remain well into 2010," Owen said. (Editing by Stephen Nisbet)