The Obama administration will trim its budget deficit forecast for fiscal 2009 to $1.58 trillion, after scrapping money earmarked for bailing out more banks, officials said on Wednesday.

The record deficit has made investors anxious and threatens to thwart Obama's ambitious domestic agenda to overhaul healthcare, reform education and make the country less reliant on fossil fuels.

Polls show the deficit is one of the top concerns of Americans who fear that it could lead to higher taxes.

An administration official said the drop in the projected deficit was due to the elimination of $250 billion that had been set aside for further possible financial rescues.

The new estimate involves a calculated judgment that financial markets have sufficiently stabilized and the administration will not have to go back to the U.S. Congress to ask for additional money to bail out more banks.

President Barack Obama says there are signs the economy is returning to normal and that his $787 billion stimulus program is working, although any recovery has a long way to go.

Officials said the government's budget office would announce next week that deficit this fiscal year would total $1.58 trillion, about $262 billion lower than the deficit forecast in May.

One official, who spoke on condition of anonymity, said the decline was due primarily to not having used the financial stabilization placeholder that was in the budget.

A further $78 billion set aside for the Federal Deposit Insurance Corp to pay for bank failures will also be saved because fewer than expected banks went under.

COLD COMFORT FOR INVESTORS?

Economists had predicted the $250 billion placeholder could be removed because of the reduced likelihood that the government would have to use more taxpayer money to bail out troubled banks.

Congress last year granted $700 billion under the Troubled Asset Relief Program to protect the country's financial system from a global credit crisis.

The improved deficit forecast may help Obama politically as he tries to overcome opposition from fiscally conservative Democrats and others opposed to the $1 trillion price tag for his healthcare overhaul.

But it may not comfort investors looking for evidence that the United States is controlling spending or generating higher revenues due to a healthier economy.

The government officials said spending this fiscal year would total $3.653 trillion and revenues would be $2.074 trillion.

The decline in the size of the deficit, from an estimate of $1.84 trillion in May, would peg it at 11.2 percent of U.S. gross domestic product, the officials said.

Investors are worried that record budget deficits will need to be funded by issuing massive amounts of government bonds, which could drive up long-term interest rates and undermine a sustainable economic recovery.

Obama has vowed to halve the deficit by the end of his four-year term, but he says massive government spending is needed now to end the country's worst recession since the Great Depression of the 1930s.

(Editing by Chris Wilson)

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