* House Republicans undecided on strategy
* CBO releases forecast of falling deficit
* Democrats insist on "clean" debt limit hike
* Treasury bill auction shows jitters over debt ceiling
By Richard Cowan and David Lawder
WASHINGTON, Feb 4 (Reuters) - Republicans said on Tuesday they hoped to attach deficit-reduction measures to legislation raising the U.S. debt limit, but a new government report that forecast a more favorable budget outlook had the potential to undercut their efforts.
The call by House of Representatives Speaker John Boehner for deficit-reduction steps was an attempt to answer the concerns of the smaller-government Tea Party activists who populate his rank-and-file.
But a series of obstacles could thwart Boehner's plans. Democrats are promising to close ranks behind President Barack Obama, who has insisted on a "clean" debt limit hike that allows the federal government to continue paying its obligations.
And Boehner's own Republicans are divided over which deficit-reduction measure or measures to link to the debt hike legislation.
As House Republicans met behind closed doors to hash out a strategy, financial markets showed some early signs of jitters over the debt ceiling, as investors pushed the interest rate on an $8 billion one-month Treasury bill auction to the highest level since the government shutdown in October.
The Treasury also began to employ extraordinary cash management measures to ensure that it can pay its bills after a temporary extension of borrowing authority expires on Saturday.
Treasury Secretary Jack Lew has warned Congress that it must act by the end of February to raise his borrowing authority or risk a historic debt default.
"Nobody wants to default on our debt," Boehner told reporters following his meeting with rank-and-file Republicans.
Boehner added that while Republicans advance legislation to raise the U.S. borrowing authority, "We ought to do something about jobs and the economy, about the drivers of our debt."
His comments came as the non-partisan Congressional Budget Office released forecasts estimating this year's budget deficit would fall to $514 billion. While sizeable, that would be down from the wrenching deficits of $1.413 trillion in fiscal 2009 and $1.3 trillion in both 2010 and 2011, which fueled heated spending-cut debates.
CBO also said that the budget deficit would fall further in fiscal 2015, to $478 billion.
Congressional aides from both parties have acknowledged that the trajectory of budget deficits could take the edge off Tea Party demands for a new round of spending cuts.
Republicans had hoped an end-of-February deadline for raising the debt ceiling or risking default would give them an opportunity to slip in some new government savings.
If there is one thing Congress does well it is react to an imminent crisis. On a superficial level, the CBO numbers offered the opposite: dwindling budget deficits as the economy recovers.
That likely means that for the next year or two, large-scale deficit reduction could be off the table, especially with Republicans more focused on repealing Obamacare than tackling tax and entitlement reforms that could fix budget headaches.
MORE THAN ONE ROADBLOCK
Besides Tuesday's CBO report, two other roadblocks stood in the way of Republican attempts to attach deficit-reduction measures to a debt limit increase.
The biggest obstacle is Democrats, who vow to enforce Obama's demand that there be no negotiations on a debt limit bill and that a simple, "clean" extension be enacted.
Senator Patty Murray, a Democrat who heads the Senate Budget Committee, urged that a no-strings-attached debt limit bill move through Congress promptly. "The longer Republicans take to dream up empty debt limit demands, the more economic uncertainty and harm they'll cause for workers, families and businesses," Murray said at a committee hearing.
Democrats aren't the only hurdle to using the debt limit to leverage greater deficit reduction.
Republicans themselves have not yet been able to decide what to attach, either in spending cuts or in job creation, to a debt limit bill.
Several ideas have been floated, ranging from demanding Obama administration approval of the construction of the Keystone XL oil pipeline from Canada to altering the "risk corridor" provisions of Obama's health insurance law, which protect insurers from certain losses.
"When we have a decision, we'll let you know," Boehner said.
Senate Democratic leader Harry Reid quipped, "The last thing we need is another manufactured crisis driven by the Tea Party-driven Republicans."
House Budget Committee Chairman Paul Ryan, noting the rough waters CBO sees long term if Congress ignores the high cost of retirement and healthcare for an aging population, said, "Washington can't continue to ignore the problem: trillions of dollars in empty promises" that will saddle Washington in coming decades.
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