Luther: "We concede to the papacy that they sit in the true Church, possessing the office instituted by Christ and inherited from the apostles"

Here's a Luther quote from the (now defunct) Catholic Answers Forums:

Did early protestant reformers agree that the catholic church was true church of Christ? [Here is a] Quote showing Martin Luther originally believed the Catholic Church was the true Church of Christ:

"Accordingly, we concede to the papacy that they sit in the true Church, possessing the office instituted by Christ and inherited from the apostles, to teach, baptize, administer the sacrament, absolve, ordain, etc., just as the Jews sat in their synagogues or assemblies and were the regularly established priesthood and authority of the Church. We admit all this and do not attack the office, although they are not willing to admit as much for us; yea, we confess that we have received these things from them, even as Christ by birth descended from the Jews and the apostles obtained the Scriptures from them." Sermon for the Sunday after Christ’s Ascension; John 15:26-16:4 (2nd sermon) A Sermon by Martin Luther; taken from his Church Postil, 1522. [This sermon is taken from volume III:254-271 of The Sermons of Martin Luther]

This snippet quote appears to be taken from a web page like this. What I found ironic is that as of the writing on this post (5/3/13), not one of 26 people who commented at the Catholic Answers forums took the time to look the quote up. 

Context
The quote is from Luther's sermon on John 15:26-16:4, a text which speaks about the oncoming persecution of those who believe in Christ. In II A 9-11, Luther explains that the early followers of Christ were to be rejected by those very people from whom they came from, the Jews. He states this is actually the popular interpretation that "the papists" begin and end at in regard to this text. But Luther states,

12. Hitherto no one has understood these words, nor can any one among the papists interpret the expression, "They shall excommunicate you" etc. They can say nothing else of this passage than that it is now an old and, in fact, a dead thing, referring to the Jews, who were a wicked and hardened people, that would not endure Christ and his apostles. It is hard to believe that even now there can be such wicked people on earth among Christians or in the Church as those who would excommunicate their brethren. But it cannot be Jews nor Turks who are meant; they have nothing to do with the Church. Nor has it ever been known that among the papists any one of them was excommunicated or persecuted or killed for the sake of the Gospel or the knowledge of Christ. Then, of course, this sermon does not concern them, and gives them neither instruction nor comfort.

13. But we, thank God, have been compelled, by our experience as preachers of the Gospel, to learn something of Christ's meaning here and why he has spoken these things. We discover, in connection with the controversy concerning doctrine which we carry on with our adversary, that the papacy with its numerous adherents has been and still is composed of the tender, pious, holy people of whom Christ here speaks, who excommunicate his Christians for the Gospel's sake and think that thereby they are rendering service to God. They certainly did this when by force they suppressed the Gospel and compelled submission, the Church accepting and obeying their mandates, and when, if anyone dared a single opposing word, he was promptly burned at the stake.

14. To exterminate the accursed heretics and enemies of God was called doing a holy work for God. In our time, also, they have shown this spirit in many examples and still show it in their treatment of numerous pious people whom they foully put to death, solely on account of their confession of faith in Christ and God, and will not consent to spare their lives even were they willing to recant. Therefore this passage does not need many annotations other than that we learn from it the difference between the true and the false Church, and thereby receive strength and comfort in our hour of a similar persecution. In view of this, let us briefly examine the words of the Gospel.

In other words, Luther is preaching that John 15:26-16:4 is describing the Roman church persecuting those who believe in the Gospel.

22. We have the comfort of this victory of Christ--that he maintains his Church against the wrath and power of the devil; but in the meantime we must endure such stabs and cruel wounds from the devil as are necessarily painful to our flesh and blood. The hardest part is that we must see and suffer all these things from those who call themselves the people of God and the Christian Church. We must learn to accept these things calmly, for neither Christ nor the saints have fared better.

23. It was also a bitter and hard thing for our first parent, Adam, to learn to understand the fulfillment in his own children of this same truth, "I will put enmity between thee" etc., when his first born and God-given son murdered his own brother because of his offering to God and his obedience to him. The patriarchs, Abraham, Isaac, and others who, for the time being, were the true Church, had to pass through the same experience when brothers who had learned from the same father one and the same faith, Word and worship of God, became enemies and one received persecution at the hands of the other. We ought not to be surprised, then, if a similar experience must be ours, not alone at the hands of the papists, from whom we have already received condemnation and whose disposition toward us is plainly apparent; but also at the hands of those who are still among us as evangelical Christians, and who yet are not upright.

In section C, Luther then goes on to explain why those committed to the papacy will become persecutors; why "such worthy people, the best, the wisest and most holy among God's children, who earnestly seek to serve and honor God, should so bitterly and mercilessly persecute Christ and his people." The basic reason is explained by Jesus: These things will they do unto you, because they have not known the Father nor me. Luther states:

26. That they do not know this Christ is true without a doubt. Their own confession and deeds prove it. It is plainly evident in what high esteem they hold themselves as being the people of God, who possess the Law, and the promise, the priesthood and worship of God (even as our people possess the Scriptures, baptism, the sacrament and the name of Christ); yet they are blind and without the true knowledge of God and of Christ, and consequently have become hardened, opposing God and his Son with their acts of ban and murder, under the very appearance and with the boast of thereby serving God. But Christ strengthens and comforts his own people that they may not fear harsh judgment, nor be intimidated by jealous authority from preaching and confession, but may say to their adversaries as the apostles answered the chief-priests and the council at Jerusalem, in Acts 5, 29: "We must obey God rather than men."

27. In this connection Christ fixes the standard of judgment and points out the difference between the true and the false Church. The Church is not to be judged by name and external appearance; but insight must be had and the identifying mark be forthcoming, by which the holy Church and the true people and servants of God may be recognized. Reason and human wisdom cannot furnish the necessary qualifications for the true Church. The actual test is in ascertaining who have the real knowledge of Christ and who have it not. Judgment cannot be passed in this case according to mere external appearance and name, according to the office and authority and power of the Church; in all these externals the Jews excelled the apostles and the papacy excels us by far.

28. Accordingly, we concede to the papacy that they sit in the true Church, possessing the office instituted by Christ and inherited from the apostles, to teach, baptize, administer the sacrament, absolve, ordain, etc., just as the Jews sat in their synagogues or assemblies and were the regularly established priesthood and authority of the Church. We admit all this and do not attack the office, although they are not willing to admit as much for us; yea, we confess that we have received these things from them, even as Christ by birth descended from the Jews and the apostles obtained the Scriptures from them.

29. In view of these prerogatives, they make their perverse boast against us and censure and curse us as obstinate and recreant apostates and enemies of the Church. It is unpleasant to suffer such reproach, and for this reason the devil easily terrifies the hearts of some of the ignorant and overwhelms men with the thought: Alas! the Church has pronounced the ban and it really possesses the office; this is certainly a thing not to be made light of, for Christ says in Mt 18, 18: "What things soever ye shall bind on earth, shall be bound in heaven." Therefore whom the Church excommunicates is undoubtedly also condemned by God. Most assuredly they do not excommunicate in the name of the devil, nor of the pope, but in the name of God the Father, of the Son, and of the Holy Spirit, by the authority of Christ etc., embellishing the ceremony with appropriate and high-sounding and solemn words.

30. It is necessary to a thorough understanding of the matter that we understand what Christ here says concerning the two Churches: One is the Church which is not recognized by the world, but is robbed of its name and exiled; the other, the Church that has the name and honor but persecutes the small flock of believers. Thus we have the opposing situations: The Church which is denied the name is the true Church, whilst the other is not the reality, though it may occupy the seat of authority and power, and possess and perform all the offices conceded to be offices and marks of the holy Church and yet we are obliged to suffer its ban and judgment.

It would be possible to continue quoting Luther expounding his point, but I let the interested reader consult the context for himself. towards the end, Luther states:

39. From these two convictions--that they do not know him and that they persecute and slay his advocates--Christ now passes the judgment that the so-called Church is not the Church. He then concludes that with their false doctrines and persecutions they are both liars and murderers of God and of Christ and of all his saints.

40. From the analysis given, you may decide for yourself in which group you are to be found; for you must be on one side or the other, and it is useless to wait for human council in this matter. It has already been unalterably determined that the two divisions can never agree. The larger body, which has the recognized authority, will always persecute the minority, even to the extent of excommunication and murder, as practiced from the beginning. Those who know Christ--the true Christians--will accept Christ's classification and be numbered with the minority, who have the Word and the knowledge of Christ, and they will suffer persecution for the faith rather than, for the sake of the friendship and honor of this world, to belong to those who, condemned by Christ, are the bitterest foes of God and of the Church, and who cannot see the kingdom of God, nor be saved.

41. In this article of faith, distinction must be made between the true Church and the false; for it is the command of God and of Christ that one shall not be confused with the other. Therefore, we must separate ourselves from the papal Church, regardless of the fact that they trust in their Church authority and condemn us as apostates.

And finally:

43. We admit that the papists also exercise the appointed offices of the Church, baptize, administer the sacrament etc., when they observe these things as the institution of Christ, in the name of Christ and by virtue of his command (just as in the Church we must regard as right and efficacious the offices of the Church and baptism administered by heretics), yet if they attempt to pervert the right use of these offices by exercising them against us, we may, by virtue of the judgment of Christ, declare their action void and regard themselves as apostates of the Church of Christ.