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UPDATE 4-U.S. congressional leaders forge budget deal that adds to deficit

* Plan also would increase U.S. debt ceiling

* Bipartisan agreement needs approval in House and Senate (Adds financial market reaction, advocacy group criticism)

WASHINGTON, Feb 7 (Reuters) - U.S. congressional leaders, in a rare display of bipartisanship, on Wednesday reached a two-year budget deal to raise government spending by almost $300 billion, attempting to curb Washington's fiscal policy squabbling but also widening the federal deficit.

The agreement, announced by the Republican and Democratic leaders of the Senate and House of Representatives, would lift caps on defense funding and some domestic spending. It also would postpone a reckoning with the federal debt limit.

Along with President Donald Trump's tax cuts that were approved by Congress in December, the new round of spending would further add to the bulging deficit and may face resistance in the House from Democrats as well as Republican fiscal hawks.

"This bill is the product of extensive negotiations among congressional leaders and the White House," Senate Majority Leader Mitch McConnell, a Republican, said on the Senate floor.

The plan will need to be passed in the House and the Senate, both controlled by Trump's fellow Republicans, before it can be sent to the White House for the president to sign into law.

House Democrats have warned they will not back the deal unless Republican House Speaker Paul Ryan promises to advance separate legislation on immigration policy.

Chuck Schumer, leader of the Senate Democrats, touted the deal, saying, "It should break the long cycle of spending crises that have snarled this Congress and hampered our middle class."

The defense spending increase in it should allow Trump to make good on his campaign promise for a military build-up.

The White House said the deal includes an extension, until March 2019, of the government's debt ceiling. The Treasury Department has been warning that without an extension in borrowing authority from Congress, the government would run out of borrowing options in the first half of next month, risking an unprecedented debt default.

The agreement also funds disaster relief, infrastructure and programs addressing opioid abuse, the Senate leaders said.

DEFICIT INCREASE

White House legislative affairs director Marc Short said the deal would increase spending by "just shy" of $300 billion.

A senior congressional aide said this amount of additional spending would not be offset by any spending cuts or new tax revenue, meaning an increase in the federal deficit.

"This really is the moment where it has become clear that despite record levels of debt and approaching trillion dollar deficits, Congress has stopped caring about what they're doing to the fiscal health of the country," said Maya MacGuineas, head of the Committee for a Responsible Federal Budget, a group that advocates for long-term fixes to Washington's debt problems.

Aside from the budget deal, lawmakers were also trying to reach agreement by Thursday to avoid a government shutdown and fund the government until March 23. If that fails, the U.S. government would suffer its second shutdown this year, after a partisan standoff over immigration policy led to a three-day partial shutdown last month.

In financial markets, yields on benchmark 10-year notes rose on news of the budget deal, on expectations of higher growth and potentially greater Treasury supply.

A large uptick in issuance is expected after Congress raises the debt ceiling, which along with higher inflation expectations has weighed on bonds in the past week.

A congressional source familiar with the agreement said it would increase non-defense spending by $131 billion and include $20 billion for infrastructure spending. It also would extend funding for the Children's Health Insurance Program (CHIP) for 10 years instead of the current six, the source added.

Passage of the plan would ease the brinkmanship over spending that roils Washington so regularly that financial markets barely flinch at the threat of a government shutdown.

Immigration again emerged as a possible point of contention. House Democratic leader Nancy Pelosi, who helped negotiate the accord, nevertheless said she would oppose it unless Ryan promises to advance legislation to protect hundreds of thousands of young adult immigrants, known as "Dreamers," brought to the United States illegally as children.

January's shutdown came after Democrats sought to have a spending bill include protections for the Dreamers that Trump has rescinded effective in March.

Republicans are eager to keep spending and immigration separate. Trump threatened on Tuesday to upend budget talks by saying he would welcome a government shutdown if Congress were not able to agree to changes in immigration law that he said would prevent criminals from entering the country.

(Additional reporting by David Morgan, Susan Heavey and Doina Chiacu in Washington and April Joyner in New York; Writing by Alistair Bell; Editing by Will Dunham)