'Challenges ahead'

"Strains persist in many financial markets across the globe, financial institutions face significant additional losses, and many businesses and households continue to experience considerable difficulty gaining access to credit," he said.

"Because of these and other factors, the economic recovery is likely to be relatively slow at first, with unemployment declining only gradually from high levels," he said.

Bernanke called on central bankers to work on policies aimed at preventing a financial crisis of the current magnitude, but said that recent moves to stabilise key markets had been effective.

"Stock prices have partially recovered, and US mortgage rates have declined markedly since last fall," he said.

The use of Federal Reserve facilities aimed at maintaining banking liquidity had declined since the beginning of the year, Bernanke said, calling the development "a clear market signal that liquidity pressures are easing and market conditions are normalising".

The broadly positive assessment by Bernanke fuelled a rally in US stock prices, with the Dow Jones Industrial Average rising 1.47 per cent to 9487.74 in mid-afternoon trading.

House sales rally

In another sign that the US economy may be stablising, sales of previously owned US houses stood at their highest level in two years during July, the National Association of Realtors (NAR) said on Friday.

Sales in July increased by 7.2 per cent to reach an annual rate of 5.24 million units, the NAR said.

The increase in sales was higher than analysts had expected; they predicted that the annualised number of units sold would stand at five million for July.

The NAR said that the increase in sales suggested that the US economy had turned the corner.

"The housing market has decisively turned for the better. We are bouncing back," Lawrence Yun, head of the organisation, said.

The NAR data shows that US house sales have risen five per cent compared to July 2008, with single-family home sales increasing 6.5 per cent and multi-family dwellings rising 12.5 per cent.

But high US unemployment could slow the pace of recovery, some analysts have said, with many homeowners behind on their mortgage payments or facing foreclosure.

While the jobless rate fell 0.1 percentage points to 9.4 per cent in July, many economists predict that it could yet go over 10 per cent of the working population before long-term recovery takes hold.