The Fed expects economic growth to slow this year and next, which "should help to limit inflation pressures over time," Bernanke said in testimony to the Senate Banking Committee.

The Fed chief, who took office Feb. 1, issued the comments as he presented the central bank's twice-a-year report on the economy and monetary policy.

Bernanke also said the Fed's rate-hiking campaign is starting to have some effect on reducing long-term inflation risks. "We're in a much more normal range of interest rates," he told the panel, referring to the difference in short- and long-term rates in the economy.

He projected a core inflation rate of about 2.25 to 2.5 percent for 2006 and said that should edge down to 2 to 2.25 percent next year.

Analysts said the Fed chairman was indicating that a pause in rate hikes may be coming.

"He's saying the rate level is just about right and over time inflation should gradually recede," said John Herrmann, director of economic commentary at Cantor Fitzgerald. "This is a strong signal that they're prepared to pause."

Bernanke's projections for core inflation exceed what is considered to be the upper range of the Fed's comfort zone, but he's wary of raising rates too high, analysts said.

"As long as the rate of inflation is not truly alarming, the Fed will pay attention to the danger that a weak and weakening real estate market poses for economic growth and employment," said Jim Grant of Grant's Interest Rate Observer newsletter.

Bernanke said the current combination of slowing growth and rising inflation readings puts the Fed in a tough spot in terms of setting interest rates, but that the Fed is taking great care to balance those risks.

He maintained a hawkish stance on inflation, saying increases in energy and other commodity prices remain a risk to the inflation outlook.

At the same time, he attempted to soothe those concerned that the economy is slowing too quickly - telling lawmakers that a recession isn't likely.

Since taking the helm from Alan Greenspan, Bernanke has sparked wild swings in the stock market for giving what some say have been mixed messages about the outlook for rates.

In his remarks Wednesday, he stressed that the Fed's credibility as an inflation fighter has a big impact on helping to keep the economy stable.

He also said the Fed is setting up a committee to help policy-makers develop a more explicit and useful form of communication.

On Wall Street, the Dow Jones industrial average soared more than 200 points after the remarks, putting the blue-chip index back above 11,000.

Meanwhile, prices in the inflation-sensitive bond market rallied, driving long-term bond yields lower. (Full story).

After the testimony, traders lowered their bets on the possibility of another Fed rate hike in August to 64 percent, from about 72 percent late Tuesday.

Investors had briefly raised their bets in the morning on the likelihood of an August hike after the Labor Department said retail prices for goods other than food and energy rose more than expected last month.

After 17 straight hikes, the Fed's key overnight lending rate stands at 5.25 percent, up from 1 percent before the central bank started hiking rates in June 2004.

Related: Highlights of Bernanke testimony

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