WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke on Wednesday signaled the U.S. central bank was ready to cut interest rates again to prevent a housing slump and shaky credit markets from further damaging a weak economy.

Delivering the Fed's semiannual report on the economy to Congress, Bernanke took note of recent elevated readings on inflation, but made clear the central bank's main concern was the economy would fail to revive later this year.

"It is important to recognize that downside risks to growth remain," Bernanke told the House of Representatives' Financial Services Committee.

"The (Fed) will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," he said.

The central bank has lowered overnight interest rates to 3 percent from 5.25 percent in five steps since mid-September. Financial markets saw Bernanke's testimony as validating bets on another half-percentage point cut at the Fed's next meeting on March 18.

"I think they are probably doing the right thing in focusing on sluggish growth more than on inflation. They're willing to inject more juice into the system, and that's what they need to do," said Firas Askari, head of currency trading at BMO Capital Markets in Toronto.

The dollar hit a record low against the euro on Bernanke's remarks, and U.S. government debt prices fell.

Stocks initially stayed mired in negative territory, but reversed course as a U.S. regulator gave a green light to housing finance companies Fannie Mae and Freddie Mac to invest more money in the mortgage market.

DELICATE BALANCE

Bernanke said that while the central bank expects inflation to moderate, risks that price pressures could remain elevated have climbed, underscoring the difficult situation policy-makers face.

"The further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month," he said. A government report last week showed consumer prices rose a steeper-than-expected 0.4 percent in January.

The Fed typically lowers interest rates to boost growth but raises borrowing costs if it wants to cool inflation pressures. Higher-than-desirable inflation could limit the central bank's options as it seeks to put a floor under the slowing economy.

If the public began to doubt the Fed's willingness to take measures to keep inflation at bay, it could hurt the central bank's ability to support growth, Bernanke added.

"Any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and could reduce the flexibility of the (Fed) to counter shortfalls of growth in the future," Bernanke added.

A week ago, the central bank lowered its forecast for 2008 economic growth by a half-point to between 1.3 percent and 2 percent, while raising its projection for unemployment and inflation.

"The risks to this outlook remain to the downside," Bernanke said.

POLICY LAGS

He noted that monetary policy affects the economy with a lag and said the Fed needed to keep in mind the economy's likely path, as well as the risks it faces.

"A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures," he said.

The struggling housing market should weigh on growth in coming quarters, he said. Higher energy prices, lower home and stock market values, and slowing job creation are likely to damp household spending, Bernanke added.

Households feeling the pinch of sliding home and stock values, and higher energy prices may hold back on the spending that provides two-thirds of the economy's thrust, Bernanke said. Slower hiring is also likely to weigh on consumers, he added.

Bernanke said financial markets remained strained in the wake of rising mortgage delinquencies and worries about credit quality. However, steps taken by the Fed and other central banks to ease credit market conditions appear to have helped.

(Additional reporting by Alister Bull; Editing by Neil Stempleman)

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