Federal Reserve Chairman Ben Bernanke on Thursday held the door open to more interest rate cuts to help the struggling economy, but told Congress the central bank expects growth to pick up later in the year.

The Fed will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks, Bernanke told the Senate Banking Committee.

He acknowledged the outlook for the economy had worsened in recent months and said risks to growth had picked up. His comments reinforced investors' expectations the central bank would lower interest rates by a half-percentage point at its next meeting on March 18.

However, the central bank chairman also said he expects sluggish growth to give way to a somewhat stronger expansion in the second half of the year as the impact of fiscal and monetary stimulus now put in place is felt.

Our policy stance must be determined in light of the medium-term forecast for real activity and inflation, as well as the risks to that forecast, he said.

The Fed has already lowered benchmark borrowing costs by 2.25 percentage points since mid-September, actions that have taken the overnight federal funds rate down to 3 percent.

Bernanke painted a somber picture of risks facing the economy, and U.S. stock prices and the dollar fell on his gloomy assessment. In early afternoon, the Dow Jones industrial average was down more than 140 points, or 1 percent.

The latest comments from Bernanke reflected a slightly softer tone than remarks a month ago, when he said the Fed stood ready to take substantive additional action -- a signal of the sharp rate cuts that followed late in the month.

U.S. short-term interest rate futures prices implied about a 20 percent chance the central bank will drop rates by three-quarters of a percentage point in March, up from the implied expectations earlier. A half-point cut is fully expected.


Bernanke told lawmakers the Fed will lower its projections for U.S. growth in forecasts to be released next week, bringing them closer into line with views in the private sector. In November, it had said the economy would likely expand 1.8 percent to 2.5 percent this year.

The Fed chairman forecast a further drop in home building and related activities, and said a softer jobs market, higher energy prices and falling home values could be expected to weigh on consumer spending in the near term.

Tighter credit is also likely to continue to hold growth back, he said. A significant worsening in financial conditions or in credit availability would certainly be a warning bell that we need to take further actions, Bernanke said.

However, he also said he saw no imminent threat that mounting losses from the subprime mortgage mess would leave banks insolvent.

Even as he outlined downside risks to growth, Bernanke noted that inflation had moved up as a result of soaring prices for oil and food and the weaker dollar, adding that inflation risks bear close watching.

To date, inflation expectations appear to have remained reasonably well anchored, but any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank's flexibility to counter shortfalls in growth in the future, he said.

Bernanke's appearance before Congress, flanked by Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox, comes at a time of turmoil.

U.S. economic growth slowed to a meager 0.6 percent annual rate in the fourth quarter of 2007, house prices have been falling, and in January the job market shrank for the first time in 53 months.

The White House and Congress put together a $168 billion fiscal stimulus plan, which was signed into law by President George W. Bush on Wednesday. The plan offers tax rebates to households and incentives for businesses to invest.

Like Bernanke, Paulson said he saw the economy dodging a recession. I believe that we are going to continue to grow, albeit at a slower rate, but risks are to the downside, he said.

(Additional reporting by Glenn Somerville, Joanne Morrison, Emily Kaiser and David Lawder; Editing by Tom Hals)