Prisoners at Styal jail, which houses women criminals and female young offenders near Manchester, told inspectors that "overt lesbian activity and drug use by some prisoners in the grounds and in the houses were ignored by staff".
The report by the Chief Inspector of Prisons also disclosed that inmates were given keys to their cells, but were being kept on locked wings.
Prison officers at Styal criticised the practise of open cells, but the Prison Service said several jails successfully used the system.
Overall the report praised the jail and said significant improvements had been made since the last inspection in 1990.
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