Thanks for all the responses guys.
Here's an update on the situation.
I tried everything everyone said- got me a hdmi cable. No good. Didn't make a blind bit of difference. So i went on sky.com to order a Sky+HD box (not order HD itself but just get the newest box). I had an old standard non + box so i figured maybe it is not allowing me to upgrade the picture to 1080i as my TV requires. (i was half right)...
Sky, who i pay £80 a month to, wanted £200 for the box (that's not a typo- TWO HUNDRED POUNDS) and £65 installation fee- fyi; there are 3 plugs in the back of your sky box- the power lead, the internet thingy and the cable. If you can pull them so they are not plugged in anymore and then push them back in (screw for the cable) to the new box so they are plugged in again then you can do it yourself. ****ing pisstakers.
I obviously did not pay £200 for the box or an installation fee. I went on ebay and bought an almost brand new one for £40. When it arrives you can use the TV but not the + facilities. You have to phone sky and get them to do a system update. It's not a lot of trouble and beats paying £65 for a technician to come round.
Anyway, the Sky+HD box has an option within to set the picture resolution to 1080i (regular Sky and Sky+ boxes to not have this option). I was hoping this because i bought a HD cable for my PS3 this week too to find it did nothing. After reading a few forums i found you had to change the picture resolution in settings from 480 or 720 to 1080i or 1080p (for 3D TVs i think). I did this with the PS3 and BINGO! the picture was perfect. 8)
So i switched the resolution on the Sky box to 1080i and... NOTHING. Still awful picture. I came to the conclusion that this is just how Sky's picture looks when you have a high res TV. Most i think don't notice it. Especially if you sit far away from the TV but get up close and look at the SKYSPORTS logo or the ITV4 logo (for example) and they're really grainy. My mum had commented that she didn't understand what was wrong as she had a Samsung HD TV and her picture was "perfect". Today i went and had a look at it. The picture was terrible. Worse than mine. Really grainy in menus and when on any channel.
So i did the only thing left... i got SkyHD

The picture is now excellent/as it ****ing should be which is great but i feel a little bit like i've been taken for a mug.
Just one thing- can anyone with a flatscreen/HD tv, with Sky TV but not a HD package take a close look at either SkySportsNews (the writing, logo etc) or of r example ITV3 (logo in the coner) and tell me if it looks grainy to you. I'd be interested to know. You only need to get about 3 feet from it (it's obviously not gonna look right if you nose is pressed up against it.

) and my betting is you'll see all grainy, pixilated 'bittiness' around said logo.