President Barack Obama forecast the biggest U.S. deficit since World War Two in a budget on Thursday that urges a costly overhaul of the healthcare system and would spend billions to arrest the economy's freefall.

An eye-popping $1.75 trillion deficit for the 2009 fiscal year dominated attention as Obama unveiled his first budget. That is the highest ever in dollar terms but more importantly to economists, it amounts to a 12.3 percent share of the economy -- the largest since 1945.

In 2010, the deficit would dip to a still-huge $1.17 trillion, Obama predicted.

Obama, a Democrat, promised to get the red ink under control but staggering deficits remained even as he planned to set new priorities that veered sharply away from the policies of his Republican predecessor President George W. Bush.

The Republican opposition in Congress was quick to condemn a budget plan that underlined Obama's intention to make good on campaign pledges to expand health coverage for the uninsured, roll back tax cuts for the wealthy and shift U.S. energy away from fossil fuels.

I don't think that we can continue on our current course. I work for the American people, and I'm determined to bring the change that the people voted for last November, said Obama, who took office on January 20 as the country reeled in the worst economic crisis in decades.

Republicans condemned the plan as showing a dedication to tax-and-spend policies, presaging major political fights getting the budget passed.

The American people know we cannot tax, spend and borrow our way back to a healthy economy, said Representative Mike Pence, a member of the Republican leadership in the House of Representatives.

The budget's hints that Obama may seek more money to fix the troubled financial system pushed banking stocks higher, but its healthcare plans delivered a hit to shares in health insurers and drugmakers.

The soaring deficit figure sent U.S. Treasury bond prices lower and yields up to three week highs on Thursday. Gold prices fell.

WORRIES OVER SPENDING

House Speaker Nancy Pelosi, a California Democrat, praised Obama's spending priorities and chided Republicans for what she saw as their new found interest in limited government.

Perhaps ... they (the Republicans) have amnesia, Pelosi said, noting that with Bush at the helm they turned budget surpluses into deficits, in part through significantly higher government spending.

But some analysts questioned whether Obama's goals were realistic at a time when the economy is still in crisis and the surging deficits threaten to burden a future recovery.

There are some good things in this budget but a lot still seems very wasteful. The market is crumbling around us and economies are in the tank, said Dan Cook, senior market analyst with IG Markets in Chicago.

Although tax cuts and social-service spending are a main part of Obama's remedies for lifting the faltering economy, the budget also pencils in the possibility of more than doubling the government's aid to the battered financial sector.

The administration put in a placeholder to buy as much as $750 billion of assets from financial firms, which have been nearly crippled by an overhang of bad mortgage debt. Bank stocks jumped on the news. Assuming one-third is lost, the ultimate cost to taxpayers would be $250 billion, the budget said.

Obama has not decided whether to seek that money.

If he does, it would come on top of an existing $700 billion financial bailout program, which has been unpopular with many Americans who see it as rewarding Wall Street bankers who made risky bets on mortgages securities.

The proposed $3.55 trillion spending blueprint for the 2010 fiscal year that begins October 1 provides the broad outlines of a more detailed one to be released in April.

But any budget requires passage by Congress to take effect. While Obama has broad support since both chambers are controlled by Democrats, he could face a fight as the sticker shock of huge deficits lead to wariness -- including among fiscal conservatives in his own party -- about expensive goals such as the healthcare overhaul.

The deficit figure reinforced concerns the government will need to sell record amounts of debt to pay for programs aimed at pulling the economy out of a deep recession.

Obama set a goal of slashing the deficit to $533 billion, or 3 percent of GDP by 2013. A rollback of the Bush tax cuts for wealthy Americans and a planned drawdown of U.S. troops from Iraq are expected to help rein in the shortfall.

WAR SPENDING

Obama is seeking an additional $75.5 billion for wars in Iraq and Afghanistan for the rest of the current fiscal year. He is requesting $130 billion for military operations in the two wars for 2010, which would be down from the roughly $140 billion he expects will be needed this year.

Washington spent about $190 billion on the wars in 2008. Obama looks likely to order U.S. combat troops to withdraw from Iraq over about 18 months, according to U.S. officials. At the same time, he is ramping up the military effort in Afghanistan.

Obama's budget proposal lays out spending cuts in farm subsidies and other areas to meet the deficit-reduction goal.

But such programs are popular with lawmakers from states with big agricultural sectors who may be loath to allow cuts.

The budget includes billions in revenues, starting in 2012, from a greenhouse gas emissions trading system. That is central to Obama's proposals to fight global warming, which are a major departure from the policies of Bush, who was widely criticized by environmentalists for resisting action.

The $85-billion U.S. college student loan business reeled from a budget proposal to axe the giant federally guaranteed student loan program. In a major shift that severely undercut shares in top student lender Sallie Mae, the budget called for moving most student lending into the direct-loan program run by the U.S. Education Department.

The $1.75 trillion budget deficit forecast for this year reflects shortfalls accumulated under Bush as well as new spending proposals under the $787 billion economic stimulus package Obama signed earlier this month.

While Obama remains highly popular with Americans, his stimulus package and other efforts to revitalize the economy have done little to win over Wall Street.

U.S. stocks prices hit 12-year lows this week.

(Additional reporting by Thomas Ferraro, Jeremy Pelofsky and Emily Kaiser in Washington and Leah Schnurr in New York, editing by Frances Kerry)

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