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The Bank of England on Wednesday forecast a sharply improving outlook for growth, indicating that it expects a V-shaped recovery, even as its projections suggested that interest rates would remain lower for longer than expected.

The central expectation in its quarterly inflation forecast, published on Wednesday, is for a growth level of 2 per cent next year and 4 per cent in 2011, much higher than the consensus among private sector economists.

The forecasts point to a return to growth after the worst recession in a generation that is similar in shape to previous recessions. This is a more positive view than the much weaker or more protracted recovery that some fear might emerge as consumers cut spending to pay debt and banks remain unable or unwilling to lend.

The Bank expects inflation to be roughly in line with its 2 per cent target in two years time if interest rates remain at 0.5 per cent and no further cash is pumped into the economy, suggesting little immediate need for further quantitative easing.

It expects inflation to be at or slightly above 2 per cent by the end of 2011, although remaining below target for much of that period. It forecasts inflation to remain below target by the end of 2011 if interest rates begin to rise slowly from the middle of next year as markets currently expect.

That suggests the Bank thinks market expectations for interest rates – which before the release of the report were for rate rises of about 1.5 percentage points next year – are too high and rates will stay lower for longer.

“We have only just started on the road to recovery,” said Mervyn King, governor of the Bank.

The Bank sees the level of output returning to pre-crisis levels by early 2011.

The Bank’s projections come after the monetary policy committee voted last week to inject a further £25bn in fresh cash into the UK economy, taking the total amount of money it has created to boost growth to £200bn.

It also follows some signs that conditions in the economy are improving, although recent data on growth from the Office of National Statistics suggested that the UK economy was still in recession in the third quarter.

“A variety of ... indicators point to a pick-up ahead,” said Mr King. But he added that “the UK economy faces a prolonged period of balance sheet adjustment” as consumers and banks reduce indebtedness, which would affect spending.

The 5 per cent fall in the core measure of the money supply over the past year, compared with a pre-crisis trend of 5 per cent growth a year, had “opened up a margin of spare capacity that will bear down on inflation”, he said.

Mr King added that he expected inflation to rise quickly above target over the next few months from its current low level of 1.1 per cent as petrol prices and the planned rise in VAT drive up prices. But the level of spare capacity and unemployment should bring inflation down thereafter.

“The risks of inflation being above or below target are broadly balanced by the end of the forecast period,” the report says. “But there are significant risks to the inflation outlook in each direction.”

Since the last inflation report in August the data have generally pointed a pick-up in activity.

When the November report was finalised – the cut-off point for data was November 4 – market interest rates were lower than in August, sterling had fallen about 4 per cent, stocks had risen by about 14 per cent, while the MPC had already decided to pump an additional £25bn of extra cash into the UK economy.

The third-quarter growth figures had been surprisingly weak, however, showing a 0.4 per cent drop in GDP compared with forecasts by the MPC in the region of 0.2 per cent growth. Mr King said he expected the figures to be revised up slightly, but not by much.

“The macroeconomic news since the August inflation report generally points to stronger growth and inflation projections,” said Simon Hayes of Barclays Capital.