(Adds finance minister quote on currency measures)
By Peter Murphy
BOGOTA, May 9 (Reuters) - Colombia's central bank chief said on Friday the economy probably grew about 4.8 percent in the first quarter of 2014 and that inflation was on course to hit its 3 percent target for the year, even as internal demand picks up.
Jose Dario Uribe said last month's quarter-point increase in the benchmark interest rate to 3.5 percent - the first in more than two years - was a "prudent" measure to keep a lid on inflation but the lending rate remained "expansionary" nonetheless.
"We see healthy dynamism in internal demand and investment," Uribe said during a televised update on inflation that he makes each quarter. He said economic output would rise to the country's potential level within 12 to 14 months.
Colombia's economy has maintained low inflation and enviable growth above 4 percent, faster than most other South American countries with the exception of Peru.
Expansion this year is expected to be higher than last year's 4.3 percent, at around 4.7 percent, the government says.
The central bank has a lower growth estimate of 4.3 percent.
Foreign cash has gushed into the Andean nation's financial markets since March 19 when investment bank J.P. Morgan said it was raising the weighting of Colombian government bonds in two of its indexes.
That has caused the peso to strengthen 6 percent in the seven weeks since that announcement. Uribe said the peso was now stronger than desired and the bank's board would discuss at its next meeting whether to keep buying dollars to limit its rise.
Board member Adolfo Meisel said on Thursday the bank could extend its dollar-purchase program beyond its scheduled June expiration.
Finance Minister Mauricio Cardenas said on Friday the government could consider using any unspent budget cash to buy dollars alongside the central bank's own purchases, to double up efforts to prevent further peso strengthening.
He ruled out any possibility that the country would resort to capital controls to tame the rise in the peso whose "equilibrium" exchange he suggested was around 1,950 to the dollar, weaker than the 1,904 it ended trading at on Friday.
"It's a matter of seizing this moment to buy dollars just like the central bank is," he said, speaking from a banking forum in Medellin, the country's second-biggest city.
Bank chief Uribe said improved industrial output would go some way toward offsetting export competitiveness lost to a stronger currency but a still-weak global economy was depressing exports.
Uribe said the El Nino weather anomaly, which brings drier weather to Colombia, could cause inflationary pressure, but probably not until the first quarter of 2015, adding that any impact would likely be finished by the second quarter.
Lack of rainfall during El Nino can drive up food prices when crops are affected and may boost the price of electricity as the nation uses more expensive gas-powered plants if water levels drop too far at its many hydroelectric dams.
Inflation for the year in 2014 could be a little above or below 3 percent, the center point of the bank's 2-4 percent target range for this year, Uribe said, adding that the interest rate rise sought to head off inflation pressures early on.
"It is a signal of prudence," he said. (Additional reporting by Nelson Bocanegra and Carlos Vargas in Medellin; Editing by Andrew Hay and Ken Wills)