Chairman of the United States Federal Reserve, Ben Bernanke. - Reuters

WASHINGTON, United States (AP):

Federal Reserve chairman Ben Bernanke told Congress yesterday the economy should grow modestly this year despite lingering pain from a housing slump and he stuck to the Fed's forecast that inflation will continue to ebb.

Still, Bernanke wasn't prepared to declare victory and close the door on the possibility of further interest rate increases. Even with recent improve-ments in 'core' or underlying inflation, the situation remains "somewhat elevated," he said.

Core inflation excludes the more volatile categories of energy and food.

Delivering the Fed's first economic report for 2007 to Capitol Hill, Bernanke offered a mostly upbeat assessment of the economy's outlook. Besides improvements on the inflation front, the Fed chief also cited some signs of stabilisation in the ailing housing market.

"Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes," the Fed chief told the Senate Banking Committee.

Bernanke's remarks pushed the blue chip Dow Jones industrial average to new levels. The index rose 87.01, or 0.69 per cent, to a new record close of 12,741.86, after reaching an intra-day high of 12,759.40.

Currently, interest rates are at a level that is "likely to foster sustainable economic growth and a gradual ebbing of core inflation", he added.

The Fed has held a key interest rate steady at 5.25 per cent since August. Before that, the central bank had steadily boosted rates for two years, the longest ever stretch of increases, to fend off inflation. Many economists predict the Fed will leave rates alone for much of this year and said the Fed chief's testimony would support that approach.

Even with his mostly positive assessment, Bernanke was careful to hedge his bets and pointed out risks that could upset the generally good economic outlook.

A predominant one is that inflation might flare up, which is why the Fed is still keeping open the option of another rate increase.

Inflation

It will "be some time before we can be confident that underlying inflation is moderating as anticipated," Bernanke said. If inflation doesn't wane as the Fed expects, policymakers are "prepared to take action," Bernanke said.

On the other hand, there is the risk that a deeper than expected residential real-estate bust could yet unfold, which could hurt overall economic growth, the Fed chairman said.

If that were to happen, Bernanke added, the Fed in theory might be inclined to lower rates to help bolster the economy. Bernanke, however, did not specifically mention the possibility of a rate cut.

A former college professor, Bernanke marked his one-year anniversary at the Fed on Februaary 1. President Bush tapped him to succeed longtime chairman Alan Greenspan, who rose to iconic status in his 18-plus years at the helm of the Fed.