LONDON (Reuters) - Britain's central bank said on Wednesday that inflation will not fall back to its 2 percent target until early 2016 but that it was still open to more bond purchases to boost Britain's stagnant economy.
It noted, however, that there were limits to what such a policy could achieve.
The economy was set for a "slow but sustained recovery" over the next three years, and economic output was unlikely to surpass its pre-financial crisis peak until 2015, the Bank of England said in its quarterly inflation report.
It forecast that inflation in two years' time was likely to be around 2.3 percent, up sharply from the 1.8 percent forecast in November. It also extended the time frame for returning to target by 18 months from what it predicted in November.
The bank's forecasts suggest inflation will peak at about 3.2 percent in the third quarter of 2013.
But in a news conference following the release of the report, outgoing Governor Mervyn King said that this would not stop the bank from pumping more money into the economy if needed.
"You might be tempted to think that an above-target inflation forecast justifies a tighter monetary policy, and certainly ensuring that inflation returns to target in the medium term is our primary responsibility and objective," he said.
"But the (bank's) remit is to deliver price stability in the medium term in a way that avoids undesirable volatility in output in the short run. The prospect of a further prolonged period of above target inflation must therefore be considered alongside the weakness of the real economy."
The Bank of England has spent 375 billion pounds ($587 billion) on buying government bonds but has held off from increasing the programme.
King said, however, that more purchases, or quantitative easing (QE), were no panacea.
"We must recognise, however, that there are limits to what can be achieved via general monetary stimulus - in any form - on its own," King said, adding that incentives to spend now reduced spending plans of households and businesses in the future.
In its report, the Bank said that much of the higher inflation was due to sterling's weakness and rises in prices partly set by the government, and that "it was appropriate to look through the temporary, albeit protracted, period of above-target inflation."
Inflation has exceeded the central bank's 2 percent target since December 2009, and its persistent failure to return to target is one reason why the bank has not increased bond purchases past the 375 billion pounds reached in October.
The Bank of England generally sets monetary policy with the aim of ensuring that inflation has returned to its 2 percent target within two years, though there is speculation that incoming governor Mark Carney, who starts in July, may take a more flexible approach.
Economists had widely expected the BoE to revise up its inflation forecast, after a more than 3 percent fall in sterling over the previous three months and the MPC's statement last Thursday that inflation might exceed 2 percent for the next two years.
The growth outlook in the report was fractionally weaker than that given in November, with growth seen rising relatively steadily to average an annual rate of around 1.9 percent by the first quarter of 2015.
Economists polled by Reuters last month expected growth of 1.0 percent this year and 1.4 percent in 2014, while inflation is expected to peak at 2.8 percent in the second quarter of 2013 before falling to average 2.0 percent over 2014 as a whole.
Some policymakers doubt whether bond purchases still have the ability to boost growth, and think alternatives such as the BoE's Funding for Lending Scheme may work better.
The BoE said that there was growing evidence that the FLS was helping private sector credit conditions, though it was too early to see an increase in net lending.
(Writing by Jeremy Gaunt; Editing by Hugh Lawson)
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