Oil slumps on demand worries

By Wanfeng Zhou

NEW YORK (Reuters) – Crude oil prices fell sharply on Monday on concerns that recent high prices could erode demand and threaten economic recovery, while the U.S. dollar firmed slightly after the U.S. federal government averted a shutdown late Friday.

Brent and U.S. crude oil prices fell early when the African Union said Libyan leader Muammar Gaddafi had accepted a road map to end the civil war, including an immediate ceasefire, though rebels said any settlement would require Gaddafi step down.

But analysts were skeptical about the peace deal, and even if an end to the civil war were in sight, it will be some time before Libyan exports return to pre-conflict levels.

Investment bank Goldman Sachs told clients there is a strong chance commodity prices may reverse, recommending they take profits.

Brent crude oil for May fell $2.93 to $123.72 a barrel, dropping as low as $123.62 after reaching a 32-month peak of $127.02. U.S. crude fell $2.87 to settle at $109.92, pulling back after reaching an early $113.46 peak, the highest intraday price since September 2008.

The U.S. dollar firmed against the euro after the U.S. Congress on Friday reached a last-minute federal budget deal that avoided a government shutdown, though traders said the focus on the U.S. debt ceiling debate could limit any gains.

A rebound in the dollar was also overdue after it fell sharply against the euro on Friday continuing its downtrend of the past four months. For the month of April, the dollar was still down about 2.0 percent.

On Monday the euro fell 0.3 percent to $1.4435, after hitting a 15-month high around $1.4486 on Friday.

“The euro’s drop today is nothing more than white noise and the pullback should prove shallow,” said Jessica Hoversen, foreign exchange and fixed income analyst at MF Global in New York.

Hoversen said the dollar’s negative tone should remain in place as long as the U.S. Federal Reserve keeps interest rates low and while central banks abroad, namely the European Central Bank and Bank of England, move closer to more normal borrowing costs.

Expectations of another rise in European Central Bank interest rates by July kept the euro close to recent highs and pushed euro zone government bond prices lower. German Bund yields briefly rose above 3.5 percent for the first time since August 2009.

The yen was off an 11-month low against the euro and a 2-1/2-year trough versus the Australian dollar as another earthquake in Japan led some investors to close riskier bets funded by cheap borrowing in the Japanese currency.

U.S. STOCKS LOWER FOR THIRD DAY

U.S. stocks ended lower for a third day, with investors nervously awaiting quarterly earnings to see if last year’s profit growth will continue in the face of rising raw material costs.

Aluminum maker Alcoa (AA.N: Quote, Profile, Research) will mark the unofficial start of the U.S. quarterly earnings reporting season when it reports results late Monday. Profits in the first quarter of 2011 at S&P 500 companies are seen rising 11.4 percent from a year ago, according to Thomson Reuters data.

“There’s a question of whether companies can meet the fairly optimistic expectations,” said John Carey, portfolio manager at Pioneer Investment Management in Boston, which has about $260 billion in assets under management. “There’s potential for disappointment, but if they come in line or above, the market could experience a continued rally.”

The Dow Jones industrial average (.DJI: Quote, Profile, Research) ended up 1.06 points at 12,381.11 but the benchmark Standard & Poor’s 500 Index (.SPX: Quote, Profile, Research) fell 3.76 points, or 0.28 percent to 1,324.41. The Nasdaq Composite Index (.IXIC: Quote, Profile, Research) lost 8.91 points, or 0.32 percent to 2,771.51.

World stocks as measured by MSCI (.MIWD00000PUS: Quote, Profile, Research) were down 0.3 percent, with emerging markets (.MSCIEF: Quote, Profile, Research) off 0.6 percent. European stocks fell, with the FTSEurofirst 300 (.FTEU3: Quote, Profile, Research) index of top European shares down 0.2 percent.

Although the world economy is fairly robust, investors increasingly expect higher commodity prices to drive up inflation, prompting central banks to tighten monetary policy.

The International Monetary Fund said on Monday it did not believe that rising commodity prices will derail the global economic recovery but warned that inflation will remain elevated for a while.

(Additional reporting by Ryan Vlastelica, Julie Haviv and Gertrude Chavez-Dreyfuss, Gene Ramos and Robert Gibbons;)

Oil slumps on demand worries