U.S. Federal Reserve Chairman Ben Bernanke said on Friday the economic recovery has weakened more than expected and the Fed stands ready to act if needed to spur slowing growth.

Bernanke downplayed concerns that the economy might slip back into recession, predicting a modest expansion in the second half of this year with the pace picking up in 2011.

If that forecast proves overly optimistic, however, he said the Fed has sufficient ammunition left and could support growth by purchasing more government debt or reducing the rate of interest paid on banks' excess reserves.

The committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly, Bernanke told the Fed conference, held in Jackson Hole, Wyoming.

Bernanke's comments, in an address to an annual conference of global central bankers hosted by the Fed, came as the government reported that the economic growth rate in the second quarter was weaker than it had originally estimated.

Bernanke made clear that the U.S. central bank has not decided what would prompt additional easing.

At this juncture, the committee has not agreed on specific criteria or triggers for further action, he said.

The overall tone was one of watch and wait, Goldman Sachs economist Jan Hatzius wrote in a note to clients, despite ongoing signs that U.S. economic activity has not only dropped below its potential growth rate but has a significant probability of weakening further.

Stocks initially fell after Bernanke's remarks, but reversed course with the three major indexes more than 1 percent higher in afternoon trade. The dollar was little changed against a basket of currencies after Bernanke's lack of a firm commitment for additional easing, which could put downward pressure on interest rates. Prices for government bonds tumbled.

OTHER OPTIONS

A string of disappointing reports on employment, housing and manufacturing have heightened concerns that the recovery is running out of steam. Economists have slashed third-quarter growth forecasts in the past couple of weeks and now see the change of a double-dip recession at 25 percent, up from 15 percent in early July, according to a Reuters poll on Friday.

With interest rates held at ultra-low levels since December 2008, the Federal Open Market Committee, the Fed's policy-setting body, has turned to other measures to bolster growth, pumping about $1.7 trillion (1.09 trillion pounds) into the economy.

Bernanke said the U.S. central bank's purchases of longer-term securities have been effective in lowering borrowing costs and that he believes the benefits of buying more such assets, if needed, would outweigh any disadvantages.

Bernanke also said other options to spur economic growth -- such as committing to hold interest rates exceptionally low for an even longer period than is currently priced in to financial markets, or raising the Fed's inflation targets -- would be less effective in the current environment.

He stressed that the high jobless rate remains a concern to policy makers, and said the Fed would be vigilant against deflation -- a dangerous downward spiral in prices that chills economic growth by making both businesses and consumers reluctant to make purchases-- even though it is not currently a risk in the United States.

Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability, he said.

Investors and economists said Bernanke's remarks indicated that he favoured more quantitative easing measures.

It's not a foregone conclusion. There is still debate about whether it should be done or not, said Andrew Harding, a bond portfolio manager at PNC Capital Advisors, in Cleveland.

Bernanke has not taken off the table more quantitative easing, specifically the buying of Treasuries outright, but it is unclear what would trigger that, Dana Saporta, economist at Credit Suisse in New York.

HAND-OFF UNDERWAY

Despite the rather sober tone of much of his remarks, which were unusually policy-heavy for a conference that tends to focus on loftier academic matters, Bernanke said he was confident the U.S. recovery would not stall.

He said while the exit from recession was driven primarily by fiscal and monetary stimulus measures and inventory rebuilding by businesses, a hand-off to consumer demand appeared to be under way.

Bernanke also downplayed a sharp widening of the trade deficit, which was a drag on second-quarter gross domestic product. The economy expanded at a 1.6 percent annualized rate between April and June, the Commerce Department reported on Friday, revising down its initial estimate of 2.4 percent.

Bernanke blamed a slow recovery in the labour market for restraining incomes and hurting consumer confidence.

The prospect for household spending depends to a significant extent on how the situation evolves, he said.

He noted conflicting signals in personal income data, which suggested consumers were indeed pulling back, but also a higher savings rate that could lead to firmer consumer spending down the line.

Holding out some hope for the beleaguered housing sector despite a terrible raft of recent data, Bernanke said falling prices and low mortgage rates should boost demand.

(Editing by Leslie Adler)

Ben Bernanke