UPDATE 2-White House budget sees unemployment peak at 10 pct

*White House sees 10-yr deficit at $9 trillion

*Report sees unemploment peaking at 10 percent

*Grim news ahead of 2010 election year (adds new quotes, data)

By Alister Bull and Andy Sullivan

WASHINGTON, Aug 25 (Reuters) - The White House on Tuesday said U.S. unemployment would be higher and the budget deficit larger than previously thought, which could slow President Barack Obama's drive to push his domestic policy plans through a skeptical Congress.

The White House deficit projections now lie closer to those of the independent Congressional Budget Office, but these will also be updated on Tuesday and may paint a grimmer picture.

The administration's midsession budget review also predicted a return to positive U.S. growth by end-2009, as the worst recession since the Great Depression ends, and lifted the pace of economic activity that it expects between 2011-2016.

Obama's central policy priority of overhauling the U.S. healthcare system has already run into trouble caused by an angry backlash from critics who complain its $1 trillion pricetag is too high and who worry it will limit choice.

And while public opinion poll numbers also show a decline in support for Obama's overall healthcare drive, the White House said the new figures showed just now important it was to get a grip on the nation's rocketing healthcare expenses.

"I know that there will be some who say this report proves that we cannot afford health reform. I think that has it backward," White House budget director Peter Orszag told reporters on a conference call.

"The size of the fiscal gap is precisely why we must enact well-designed and fiscally responsible health reform now."

The White House budget report was overshadowed by Obama's move to name Federal Reserve Chairman Ben Bernanke to a second term, seeking to keep him in place to steer the world's largest economy out of its downturn.

SHORT-TERM GAINS

Orszag confirmed the budget deficit would be a smaller than initially thought $1.58 trillion in fiscal 2009, due mainly to $250 billion earmarked for bank bailouts being dropped.

In addition, he said the deficit between 2010 and 2019 would total about $9 trillion, or $2 trillion more than forecast when the White House updated its initial budget projections in May. These numbers were leaked last week.

As a percentage of GDP, the budget deficit will touch 11.2 percent in fiscal 2009, edge down to 10.4 percent in 2010 and then fall fairly smartly and hover around 4 percent out to 2019.

Orszag did, however, say that the bulk of this burden would be made up of interest payments due to the build-up of the national debt following the recession.

He noted this also reflected an assumption that 10-year government bond yields would rise to an average of 5.2 percent in 2012 from 3.6 percent this year as the unusually strong demand for Treasuries as a safe haven abated.

The White House firmly pinned the blame for the deficit deterioration on the recession Obama inherited from Republican President George W Bush, for driving up government spending on things like unemployment insurance and food stamps.

"Whatever their cause, the administration is very concerned about these out-year deficits, and getting those deficits under control is a top priority of the administration," Orszag said.

But with congressional elections looming next year, Obama will be pressed to show he is serious about cutting costs.

Investors worry rising deficits will either push up inflation or force the administration to raise taxes to bolster revenues. Orszag said measures to curb the deficit would be outlined in the 2011 budget but declined to give details.

The midsession budget review forecast the economy would shrink by 2.8 percent year-over-year in 2009, but grow 2.0 percent in 2010 and by 3.8 percent in 2011.

"We do expect a period of sustained above-normal growth in the period of 2011-2016, then settling down to normal long run growth of 2-1/2 percent to 2.6 percent," White House Council of Economic Advisers chairwoman Christina Romer told the call.

She said the projection for unemployment had been raised substantially since may, to 9.3 percent on average in 2009 and 9.8 percent in 2010, and she saw it peaking at 10 percent in the final three months of this year.

"The unemployment rate will stay probably at 10 percent in the beginning of 2010 and then start to come down," she said.

As a result of the larger deficit, the ratio of national debt to gross domestic product would rise from 48 percent in 2009 to 57 percent in 2010 and almost 69 percent by 2019

(Reporting by Alister Bull; Editing by Simon Denyer)