Federal Reserve Board Chariman Ben Bernanke predicts economic activity will likely bottom out and then turn upward later this year, according to his testimony before the House Budget Committee this morning. "Our assessments that consumer spending and housing demand will stabilize and that the pace of inventory liquidation will slow are key building blocks of that forecast," he said. Consumer spending, which dropped sharply in the second half of last year, has been roughly flat since the beginning of the year, at the same time consumer sentiment has improved. The Fed says the government's fiscal stimulus program will further boost households' spending power in coming months. Nonetheless, a weak labor market, declines in equity and housing wealth and tight credit conditions will continue to negatively impact spending, Bernanke warned. On the upside, with home sales on the rise and home price declines on the slowdown, the housing market looks a bit brighter. And while the construction of new homes has been sufficiently retrained -- bad news for home builders -- the backlog of unsold new homes is diminishing, according to reports by the US Census Bureau and the Department of Housing and Urban Development, which is vital to a recovery in homebuilding. Increased consumer spending and improved housing conditions, however, will not be enough to drive a full recovery. "An important caveat is that our forecast also assumes continuing gradual repair of the financial system and an associated improvement in credit conditions," Bernanke said. "A relapse in the financial sector would be a significant drag on economic activity and could cause the incipient recovery to stall." And even after a recovery is under way, Bernanke cautioned the economy will only gradually gain momentum. Economic slack will fade away slowly. In particular, he says, businesses are likely to be cautious about hiring. Write to Kelly Curran.