LONDON (Reuters) - Britain must do more to bolster demand and the Bank of England should purchase more assets or even cut its main interest rate - already at a record low - to prevent years of sluggish growth, the International Monetary Fund said on Tuesday.
Britain has not fully recovered from the slump caused by the 2007-2009 financial crisis, and the economy fell back into recession around the turn of the year.
"Growth is too slow and unemployment, including youth unemployment, is too high," IMF Managing Director Christine Lagarde said at a news conference. "Policies to bolster demand before low growth becomes entrenched are needed."
The IMF chief suggested the government rejig its austerity program to allow more infrastructure spending while the central bank should buy more assets, possibly also bonds from companies or mortgages, or cut rates.
The Bank of England has bought 325 billion pounds worth of government bonds with newly created money to boost the faltering economy, but halted the money printing presses this month on concerns over stubbornly high inflation.
It may have more room for additional easing, however, after data on Tuesday showed UK inflation fell to 3 percent in April, its lowest level in more than two years.
The IMF continued to back the government's austerity plan in principle, though it applauded last November's decision to prolongue the austerity period rather than cut faster.
In a separate report, the Organisation for Economic Cooperation and Development called Britain's policy mix appropriate, but it pointed out risks including a weaker global economy and higher oil prices.
International backing for the government's plan of tax hikes and spending cuts to close a gaping budget deficit is crucial for finance minister George Osborne, as the government has come under attack for the lack of UK economic growth.
Britain's budget deficit topped 11 percent after the crisis, and Osborne said in November that balancing the books would entail two more years of austerity than originally planned.
The IMF said in its concluding statement after its annual review of the British economy that the recovery should gain pace later this year but much productive capacity will remain unused for a longer time, increasing the danger that it will be lost.
Threats to the already weak economy were large and an escalation of the euro debt crisis could lead to a self-reinforcing cycle of lower confidence and exports, higher bank funding costs, tighter credit and falling asset prices.
The Fund did not give fresh growth forecasts. In April the IMF had forecast growth of 0.8 percent for 2012, the same as the government's independent forecasting body, and 2.0 percent for 2013, following growth of just 0.7 percent in 2011.
The IMF said inflation was set to fall below the central bank's 2 percent target over the next 18-24 months.
The government should explore further steps to make more credit available to companies, the IMF said. The central bank could act as an agent to buy private sector bonds or provide longer-term bank funding against a broad range of collateral.
BoE governor Mervyn King, who left the door open for easing when presenting the Bank's new forecasts last week, has been adamant that buying private sector assets was a decision for the government to take as it amounted to a subsidy for firms.
The Fund also urged the BoE's new regulatory body - the Financial Policy Committee - to give clear guidance about the speed at which banks had to comply with new capital rules, as too fast a pace could hit credit supply further.
The IMF said the government should rejig its spending cuts to help spur growth, saying money could be freed up through property tax reform, more restraint on public employee compensation and better targeting of transfers to those in need.
Should the recovery fail to take off, the government should delay fiscal consolidation and ease fiscal policy, preferably through temporary tax cuts and greater infrastructure spending, the IMF said.
Additional reporting by David Milliken and Mohammed Abbas; Editing by Hugh Lawson