Federal Reserve Chairman Ben Bernanke told Congress on Wednesday a weak job market and tame inflation warrant low interest rates for an extended period, dampening speculation a policy tightening might be nearing.

In his first appearance before Congress following a testy confirmation vote in the Senate last month, Bernanke offered a relatively somber assessment of the economy despite recent signs of strong growth.

The country has lost 8.4 million jobs in a little more than two years in the most severe economic downturn since the Great Depression. The Fed chief said job losses were abating, but acknowledged the recession's toll on American workers.

Notwithstanding the positive signs, the job market remains quite weak, Bernanke told the House of Representatives Financial Services Committee.

Bernanke, delivering the Fed's semiannual report to Congress, said the U.S. central bank's policy-setting Federal Open Market Committee was prepared to support the economy with extraordinary stimulus for some time.

The FOMC continues to anticipate that economic conditions -- including low rates of resource utilization, subdued inflation trends, and stable inflation expectations -- are likely to warrant exceptionally low levels of the federal funds rate for an extended period, he said, echoing the Fed's most recent policy statement in late January.

Fed officials have held the benchmark overnight interbank rate in a zero to 0.25 percent range since December 2008 and have suggested they would likely wait several months after removing the extended period phrase from their policy statement before proceeding to raise it.

U.S. stocks were solidly higher by mid afternoon as bank shares benefited from Bernanke's low-rate vow, ignoring a surprisingly weak report on new home sales that highlighted the Fed's predicament.

New home sales slumped more than 11 percent in January even as the central bank's purchase of mortgage-related bonds and a home-buyer tax credit continued to support the market. Many analysts worry things could get even uglier in coming months after both those programs expire.

We may be in for a rough ride in housing, said Adam York, economist at Wells Fargo in Charlotte, North Carolina.

BUDGET POLITICS

Commercial real estate, where defaults are supposed to spike this year, also remains a key concern. Bernanke called it the biggest credit issue we still have.

Bernanke's reassurances about keeping rate increases at bay helped U.S. government bonds erase losses, and drove the dollar lower against the euro and Japanese yen. Interest rate futures pared expectations of rate hikes before year-end.

Legislators on both sides of the isle used the hearing to play out the ongoing tug-of-war in Congress over budget deficits. Committee Chairman Barney Frank leaned on Bernanke to argue that the fiscal stimulus measures enacted by Democrats have helped alleviate some of the nation's employment losses.

Republicans, for their part, wanted Bernanke's view on the long-term implications of the government's funding gap, which he said was not on a sustainable path.

While he said he did not believe the U.S. credit rating would be downgraded, he warned that bond market worries on growing U.S. debt could send interest rates higher and added there was a also some chance, if small, of a sharp dollar drop.

I think it would be helpful for the current situation if the Congress and the administration ... could provide a plan which shows how the deficit will fall, Bernanke said.

STICKS TO SCRIPT

The Fed last week surprised markets by raising the discount rate it charges on direct emergency loans to banks.

The increase spurred fears the central bank was about to embark on a broader push for higher borrowing costs, even though the Fed made no change to the federal funds rate, its main policy tool.

The central bank said the discount rate move was simply an effort to pull back on the measures it had taken to increase liquidity in financial markets, a message Bernanke repeated on Wednesday.

He stuck to the playbook, said John Canally, an economist at LPL Financial in Boston.

Bernanke said, however, that the time would come for tighter policy and argued the Fed possesses a broad array of tools to remove such accommodation when the time is right.

Among the Fed's options, he said, are transactions that would drain excess money from the financial system. One such program, a term deposit facility that would give banks the incentive to park their money at the central bank, could be operational shortly after being tested this spring, the Fed said in its semiannual report.

Most analysts do not expect the Fed to raise the federal funds rate until sometime in the second half of the year, at the earliest. Similarly, a Reuters poll released on Wednesday showed economists expect the European Central Bank to keep euro zone interest rates on hold until the fourth quarter.

(Additional reporting by Emily Kaiser; Editing by Andrew Hay)

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