OAK BLUFFS, Massachusetts (Reuters) - US President Barack Obama nominated Ben Bernanke to a second term as Federal Reserve chairman yesterday, aiming for continuity at a time when the US economy is breaking free from a deep recession.

Obama interrupted his vacation on the Massachusetts island of Martha's Vineyard to make the announcement with the 55-year-old Bernanke at his side.

"Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and outside-the-box thinking that has helped put the brakes on our economic freefall," Obama said.

Obama said the US auto industry was "showing signs of life" and business investment was stabilising, after the deepest recession since the Great Depression. The housing and credit markets had also been saved from collapse, he said.

The announcement may have been timed to deflect attention from other less market-friendly news yesterday. The White House raised its 10-year budget deficit projection by $2 trillion to approximately $9 trillion and said it expected unemployment to peak at 10 percent.

Congress' budget watchdog calculated that the federal government will spend a record $1.59 trillion more than it collects in the current fiscal year, and that the 10-year budget deficit would reach $7.14 trillion. Financial markets had expected Bernanke to get a second four-year term from February 1, 2010, but were not anticipating an announcement so far in advance.

Obama administration officials had repeatedly stressed before the president began a week-long vacation on Sunday that he would not be making news.

A White House official, however, said Obama had wanted to "put to rest" speculation about the future of the Fed chairman.

Obama is counting on Bernanke, a soft-spoken former Princeton University professor, to nurse the economy back to health at a time when unemployment, home foreclosures and bank failures are still mounting.

Bernanke, whose appointment must be confirmed by the Senate, has pushed US interest rates to near zero and flooded financial markets with hundreds of billions of dollars to stem a credit crisis and turn back recession.

Joining Obama in a school hall in the town of Oak Bluffs, Bernanke shook hands with the president before praising his support for a strong and independent Federal Reserve.

"We have been bold or deliberate as circumstances demanded, but our objective remains constant: to restore a more stable economic and financial environment in which opportunity can again flourish, and in which Americans' hard work and creativity can receive their proper rewards," Bernanke said.

While many analysts think the long US downturn has ended, they expect a sluggish recovery and some worry the economy could easily tip back into recession. Obama's Democrats control the Senate, but Bernanke has faced criticism from lawmakers of both parties who say he has gone too far in extending Fed support that will be difficult to unwind, threatening future inflation.

"While I have had serious differences with the Federal Reserve over the past few years, I think reappointing chairman Bernanke is probably the right choice," Senate Banking Committee chairman Christopher Dodd said in a statement.

Dodd vowed a "thorough and comprehensive" hearing to consider the nomination.

Analysts suggested Obama was aiming for stability.

"Agree or not, the types of applications and the size of the intervention are now established in the annals of Fed policy-making as one of the most dramatic responses ever," said David Kotok, chairman of Cumberland Advisors in Vineland, New Jersey.

The other main candidate had been Lawrence Summers, Obama's top White House economic adviser and a former U.S. Treasury secretary. But the choice of Summers would have been seen by many as threatening the Fed's independence.