By Burton Frierson

NEW YORK (Reuters) - Weak retail sales and a rise in producer prices at their highest annual rate in 27 years provided further evidence of "stagflation" in the U.S. economy on Tuesday.

Federal Reserve Chairman Ben Bernanke reinforced the troubled outlook for the world's largest economy, saying growth faced significant downside risks, even though the Fed raised its forecast for economic growth as well as for inflation.

In its semi-annual monetary policy report to Congress, the Fed raised its projection for growth in 2008, but this provided cold comfort to investors hit by the downturn in the stockmarket and to consumers facing soaring energy prices and higher unemployment.

Economists attributed the Fed's rosier growth outlook to government economic stimulus checks, which many consumers have already spent.

The U.S. Labor Department said producer prices over the last 12 months jumped 9.2 percent, the biggest increase since a 10.4 percent gain in June 1981 when the United States was last mired in a stagflationary period of low growth and high inflation.

"The PPI number is just outrageous," said T.J. Marta, fixed-income strategist at RBC Capital Markets in New York.

On Wall Street, U.S. stocks initially fell after Bernanke's comments but later recovered on optimism over a fall in oil prices on Tuesday.

The U.S. dollar was also weaker after seeing a new record low against the euro overnight. U.S. government bonds, which generally benefit in times of economic weakness, saw their yields fall as investors pared their bets on the possibility of Fed interest rate rises this year.