Current growth in student numbers means ministers' goal of 50% participation by 2010 will not be met, the funding council for England has said.
Universities still need to recruit under-represented groups, Hefce says
Hefce announced that funding for higher education in England would rise by almost 6% this year.
And it said £6.7bn would be available next year, including an increase for recruiting more students.
The government said it was committed to "making progress" towards having half of young people in higher education.
It was an "economic and social necessity" said Higher Education Minister Bill Rammell.
The funding council said that participation (the proportion of young people in higher education) currently stood at 42.5%, and was predicted to rise to 43% next year.
It said the rate of growth would not be enough to ensure a rise to 50% by 2010.
But £344m had been allocated to support the widening of participation of students from under-represented groups, and those at risk of not completing their studies.
There had been concerns that there would be no substantial rise in higher education funding this year, since universities will gain increased revenue from variable tuition fees for the first time from September.
But funding for teaching will rise by 6.3% to £4,228 - and there will be an increase of 8.5% for capital funding, including research equipment.
Acting chief executive of Hefce, Steve Egan, said: "This represents a good settlement for universities and colleges.
"Building on previous announcements, funding for 2006-07 continues to make significant inroads into the cumulative effect of years of under-funding of higher education."
He said the increase in funding, together with additional income from fees, would provide them with a "solid platform" to develop.
He added that the resources would help institutions meet one of the "biggest challenges" facing higher education - recruitment and retention of under-represented groups.
The settlement will also provide an extra £98m to provide extra student places, of which £18m is for new medical and dental students.
'No cap on ambition'
Hefce funds individual institutions according to their number of students, subject mix and quality of research.
A spokesperson for Universities UK said the settlement would go some way towards enabling institutions to pursue objectives of widening participation, engaging in world-class research and raising student numbers.
"Universities are fully committed to making higher education open to all and we're pleased that additional funding has been made available," the spokesperson said.
Higher Education Minister Bill Rammell said: "Our commitment has always been to make progress towards 50% participation in HE for 18-30 year olds by 2010... because it is both an economic and social necessity.
"At the heart of government education policies is the belief that people with aspiration and talent, irrespective of background, must have the opportunity to get on in life. We should not put a cap on ambition.
"That is why the government believes we need to expand, not restrict, the numbers that go to university. "