Bernanke: Markets under stress, outlook uncertain

By Emily Kaiser and Mark Felsenthal

WASHINGTON (Reuters) - A weakening housing market, a strained banking system, and rising oil prices threaten the U.S. economy, and restoring financial market stability is a top priority, Federal Reserve Chairman Ben Bernanke said on Tuesday.

It was a gloomier assessment than the central bank's policy-setting panel gave in late June, when it said risks to economic growth had diminished somewhat.

Bernanke, in his semi-annual testimony on economic conditions to lawmakers on Tuesday, acknowledged that financial markets had grown increasingly anxious in recent weeks, particularly over the financial condition of mortgage finance companies Fannie Mae and Freddie Mac.

He stressed that the outlook for economic growth and inflation was unusually uncertain. Investors took that as a signal that the Fed would keep interest rates unchanged at least through August, and perhaps through the end of the year.

"The possibility of higher energy prices, tighter credit conditions, and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately," he said.

Bernanke said the slumping housing market was "the most critical and central issue that we face," because it held the key to consumer spending as well as banks' financial health.

"The testimony represents a significant retreat and does imply that the Fed will not be moving to hike (interest) rates anytime soon," said Joseph Brusuelas, chief economist with Merk Investments.

Bernanke's comments come just two days after the Treasury Department, in close coordination with the central bank, announced measures to aid Fannie Mae and Freddie Mac, which have been under pressure as the housing market has deteriorated.