Bernanke's testimony on economic outlook

WASHINGTON (Reuters) - U.S. Federal Reserve Chairman Ben Bernanke testified on the economy's outlook and financial markets to the House Budget Committee on Monday.

Following are highlights from his prepared testimony and the question and answer session.

From question and answer session:

HOW FANNIE MAE AND FREDDIE MAC COULD HELP MORTGAGE MARKETS:

"In particular, Fannie and Freddie, the stabilization of those two companies, I think despite some run-up in mortgage rates last week, I do think will provide more credit, more available credit for homeowners going forward. Congress of course has just passed the Hope for Homeowners bill which allows troubled mortgages to be written down in terms of principal and renegotiated and refinanced into the Federal Housing Administration. Further steps could be taken along those lines, if the Congress wished to. The Congress could also further support Fannie and Freddie's funding and address some of the costs that they face in order to make more credit available to the mortgage market."

From prepared testimony:

ON THE FINANCIAL RESCUE LEGISLATION

"I am confident that these initiatives, together with other actions by the Treasury, the Federal Reserve, and other regulators, will help restore trust in our financial system and allow the resumption of more-normal flows of credit to households and firms.

ECONOMIC OUTLOOK

"The stabilization of the financial system, though an essential first step, will not quickly eliminate the challenges still faced by the broader economy. ... The pace of economic activity is likely to be below that of its longer-run potential for several quarters."

INFLATION OUTLOOK

The effects of surging commodity prices on consumer costs "are now reversing in the wake of the substantial declines in commodity prices since the summer. Moreover, the prices of imports now appear to be decelerating, and consumer surveys and yields on inflation-indexed Treasury securities suggest that expected inflation has held steady or eased. If not reversed, these developments, together with the likelihood that economic activity will fall short of potential for a time, should bring inflation down to levels consistent with price stability."