Federal Reserve Chairman Ben Bernanke on Wednesday suggested U.S. economic conditions are still too weak for the central bank to pull back on its vast monetary stimulus, despite a welcome drop in the jobless rate.

The Fed chief, testifying to the House of Representatives Budget Committee, also warned about the dangers of record U.S. budget deficits. But he indicated sharp spending cuts in the short term could cripple the recovery.

Acknowledging a recent pick-up in the economy, Bernanke said a drop in the jobless rate to 9 percent in January from 9.8 percent in November, the biggest two-month decline since 1958, was grounds for optimism.

However, he said hiring is still anemic and noted that the economy has made up just over one million of the more than eight million jobs lost during the recession.

This gain was ... not enough to significantly erode the wide margin of slack that remains in our labor market, he added.

In November, the Fed launched a plan to buy $600 billion in government debt to keep a lid on long-term borrowing costs and support a fragile economic rebound.

That program drew ire from many policymakers in emerging markets, who accused the United States of unfairly driving down the value of the U.S. dollar to boost exports. At home, many Republican lawmakers attacked the program as potentially sowing the seeds of inflation.

Pressed by skeptical lawmakers, Bernanke said the Fed regularly reviews its bond buying, but also indicated he feels it is still needed. He repeated that it would take four to five years for unemployment to return to more normal levels closer to 5 percent.

The chairman continues to deliver the same message of caution and patience despite the better-than-expected data flow observed in recent months, said Michael Gapen, economist at Barclays Capital in New York.

Bernanke said U.S. inflation remains quite low, a tough message to deliver amid headlines of rising food and commodity costs across the globe.

He also said expectations of future inflation had remained stable, suggesting little worry that an inflationary psychology was building despite rising gasoline costs.

BERNANKE PING-PONG

It was Bernanke first appearance before a House panel since Republicans assumed control of the chamber last month. While the tone of the hearing was generally civil, some of the questioning was pointed.

The panel's chairman, Republican Rep. Paul Ryan of Wisconsin, opened the hearing by criticizing the Fed for providing the fuel for future bubbles and inflation, suggesting the bond purchases were eroding the dollar's value.

There is nothing more insidious that a country can do to its citizens than debase its currency, Ryan said.

Both Democrats and Republicans tried to get Bernanke to back their views on how best to attack a budget deficit that is expected to hit a record $1.5 trillion this year. Republicans want to rein in outlays and ward off any tax increases; Democrats are wary of cutting spending too deeply now.

Bernanke offered a fig leaf to both sides, supporting lower taxes on the one hand while maintaining that short-term budget reductions should not be too radical.

It's really a question of convincing the market that there's a long-term plan here, Bernanke said, adding that budget cuts should be done in a growth-friendly way.

He said Congress should consider closing corporate tax loopholes to broaden the tax base so that the corporate tax rate could be reduced. He also repeated a warning about the dire consequences of not lifting the country's debt ceiling.

Asked about the future of government-sponsored enterprises like Fannie Mae and Freddie Mac, Bernanke said government backing for the mortgage sector should be a last resort, not common practice.

(Editing by Dan Grebler)

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