Although the country's economic growth - bruised by housing, credit and financial debacles - is still fragile, Bernanke on Tuesday expressed hope for some improvement in the second half of this year.
At the same time, he sounded a notably louder warning against inflation threats. To this end, he raised his biggest public concern to date about the slide in the U.S. dollar, saying it has contributed to an "unwelcome rise" in inflation.
The Fed chief's fresh assessment - delivered via satellite to an international monetary conference in Spain - appeared to mark a subtle shift in Bernanke's views about economic risks.
Despite the rising concerns about inflation, Bernanke signaled the Fed is inclined to leave rates where they are. Boosting them could further weaken the economy's delicate state.
However, some analysts said Bernanke might be taking a baby step toward laying the foundation for an eventual rise in rates - possibly later this year or early next year - if inflation were to flash signs of getting dangerously out of hand.
"Bernanke has inflation on the brain," said Richard Yamarone, an economist at Argus Research.
To help brace the economy, the Fed dropped rates in late April to 2 percent, a nearly four-year low, continuing a rate-cutting campaign that started last September. "For now policy seems well positioned to promote moderate growth and price stability over time," Bernanke said.
Many economists believe the Fed will hold rates steady at its next meeting on June 24-25 and probably through much, if not all, of this year. However, some believe that inflation could flare up and force the Fed to begin boosting rates later this year or next year.
On Wall Street, stocks tumbled as investors grew more fearful about credit stresses at financial companies. The Dow Jones industrials sank 100.97 points.
The Fed's juggling act has gotten harder. It is trying to right a wobbly economy without aggravating inflation.
The Fed's aggressive rate-cutting campaign has contributed to a lower value of the U.S. dollar. That, in turn, has contributed to increases in the price of imported goods and in consumer prices. "We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations," Bernanke said, in a relatively rare public discussion of the dollar.
In the first four months of this year, consumer prices have risen at an annual rate of 3 percent. That's down from a 4.1 percent rise - the biggest in 17 years - registered in 2007, but it's still too high for the Fed's taste.
"Inflation has remained high," Bernanke said. "The possibility that commodity prices will continue to rise is an important risk to the inflation forecast," he said.
During a question-and-answer session, Bernanke called the dollar's impact on the rise in commodity prices "relatively modest" and said that global supply and demand conditions were more important factors driving up energy and other prices. Still, the "weaker dollar does have inflationary impact" and the Fed is attuned to that, he added.
The Fed is continuing to "carefully monitor developments in foreign-exchange markets," he said. After Bernanke's remarks, the dollar - which has fallen sharply against the euro in the past year - gained some muscle. Short of raising rates, the Fed can try to talk up the dollar through tough anti-inflation rhetoric, analysts said.
Meanwhile, if already lofty oil prices, which peaked at $135.09 a barrel in late May, were to continue to rise, that could worsen inflation, Bernanke warned. Oil prices retreated after Bernanke's remarks, dipping to just below $124 a barrel.
If consumers, investors and businesses believe inflation will continue to go up, they will change their behavior in ways that aggravate inflation, turning it into a self-fulfilling prophecy, Bernanke said.
Although Bernanke said economic growth in the current quarter is "likely to be relatively weak," he reiterated the Fed's hope for a pickup in growth in the second half of this year and into 2009. The Fed's powerful doses of rate reductions along with the government's $168 billion stimulus package, including rebates for people and tax breaks for businesses, should bring about "somewhat better economic conditions" in the second half of this year, he said.
However, until the slumping housing market and falling home prices show "clearer signs of stabilization," there will continue to be threats to economic growth getting back to full throttle, he added. And, recent increases in oil prices pose "additional downside risks to growth," he said.
"Consumer spending has thus far held up a bit better than expected, but households continue to face significant headwinds, including falling house prices, a softer job market, tighter credit and higher energy prices," Bernanke said. Consumer spending is a major shaper of overall economic activity.
Businesses, too, are facing challenges, including rapidly escalating costs of raw materials and weaker demand from U.S. consumers, Bernanke said.
Observed Lynn Reaser, chief economist at Bank of America's Investment Strategies Group: "The Fed certainly does not want to see a repeat of the 1970s experience" of rising inflation combined with stagnant economic growth, a toxic mixed called "stagflation."
