Federal Reserve chairman Ben Bernanke softened his previously hawkish stance on monetary policy, suggesting in testimony to the Senate Banking Committee that policy makers have become increasingly uncertain about the direction of interest rates amid a roiling financial market that has become increasingly unraveled in the past week. “In the housing sector, activity continues to weaken,” Bernanke said. “Although sales of existing homes have been about unchanged this year, sales of new homes have continued to fall, and inventories of unsold new homes remain high.” “The declines in home prices have contributed to the rising tide of foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in turn, intensified the downward pressure on home prices in some areas.” Bernanke acknowledged what numerous commentators have suggested for at least a month: that the Fed faces an increasingly unsavory monetary policy combination of rising inflation and an economy that is at the very least slowing, if not already landing directly into recessionary territory. That’s the very recipe for stagflation, even if Bernanke didn’t use the word in his testimony. “The possibility of higher energy prices, tighter credit conditions, and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth,” he said. “At the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation and some measures of inflation expectations have moved higher.” Bernanke’s remarks did little to assuage investor concern, although they did suggest that the Fed is increasingly unlikely to raise rates — but if anything, his confirmation of economic headwinds confirmed speculation that the Fed is facing an increasingly difficult set of policy choices in the months ahead, as energy prices continue to soar. The Dow fell more than 200 points in early trading, at 10,854.00 and off 1.81 percent when this story was published. Not helping matters was an ever-weakening dollar — which fell to a record low against the Euro Tuesday morning, and is one of the key factors cited behind surging oil and commodity prices. With Bernanke’s policy hand likely forced by a weak economy, it’s likely that the dollar won’t be able to stage a strong rebound soon, sources suggested to HW Tuesday (rates at the ECB and BOE are well above the Fed’s, giving money managers a huge incentive to sell off the dollar). Links: Bernanke’s complete testimony