LONDON (Reuters) - The Bank of England said yesterday it expected a slower recovery than it had forecast previously with inflation remaining well below target, suggesting monetary policy will stay loose for some time.

The BoE stressed a high level of uncertainty around its forecasts which showed the economy shrinking at an annual rate of around 4.5 percent in the second quarter of 2009 before recovering at the start of 2010.

That is a later recovery than in the BoE's last quarterly report in February and Governor Mervyn King said that although there were signs the pace of decline was starting to ease, the recovery would be slow and highly uncertain.

"Growth has just as much chance of being positive over the next 12 months as it has of being negative," King told reporters. "We may well get a recovery that proves to be sustained, then again we may not."

Sterling fell almost a cent against the dollar and Britain's top FTSE 100 share index fell after the BoE's Inflation Report showed inflation at just above one percent in two years' time and holding below the official two percent target well into 2012.

UK interest rates are at a record low 0.5 percent and the BoE has recently expanded its asset purchase programme to £125 billion ($189.6 billion) to boost the supply of credit to Britain's recession-hit economy.

King said he was not disappointed with the impact of its quantitative easing efforts so far but said it would take time before they were reflected in economic data.

Gilt futures jumped more a full point after the report, buoyed by the cautious outlook for the economy and bets the central bank may even expand its asset purchase programme.

"The message here is that they are going to be in no hurry at all to start to tighten policy, whether that is through a reversal of quantitative easing or higher interest rates," said Jonathan Loynes, chief UK economist at Capital Economics.

"It seems to me to inject a bit of caution amidst all the talk of green shoots of recovering."

King said the prospect of necessary fiscal consolidation in many countries after the downturn would put a drag on recovery but there was a big UK stimulus already in train from fiscal and monetary action, weak sterling and falls in commodity prices.

But he highlighted the difficulties that were still holding banks back from lending, noting UK banks were not filling the void left by the retreat of foreign lenders.

"The projected distribution for GDP growth is weaker than in the February report, reflecting lower-than-expected activity in the first quarter of 2009 both at home and abroad and a judgement that it is likely to take longer for bank lending to return to normal than assumed in February," the report said.

However, King said it had been helpful the government had been "extremely honest" about the fiscal problems it faced.

Last month, finance minister Alistair Darling forecast government borrowing at a record £175 billion this year and estimated the economy would shrink by about 3.5 percent this year, which would be the fastest rate of contraction since 1945.

Analysts say those estimates now look overly optimistic, especially given a bigger-than-expected 1.9 percent drop in output in the first three months of this year — the biggest quarterly fall since 1979.

A Reuters poll, conducted before the BoE published the Inflation Report, showed economists expect the economy to shrink by four percent this year.