NEW YORK - Oil prices tumbled more than 2 percent on Thursday to below $89 a barrel as a stronger dollar and weaker U.S. equities deterred buyers.
Oil markets fell back as Wall Street dipped on disappointing retail sales and investors turned cautious ahead of Friday's U.S. employment report for December.
Oil's losses added to a volatile start to trading in the New Year, with crude extending December's gains and touching a 27-month high on Monday before investors began to reassess the optimistic outlook for commodities in 2011.
Thursday saw further pressure on oil from gains in the dollar against the euro which weighed on dollar-denominated commodities. Recent U.S. data has painted a rosier economic picture in contrast to worries about the euro zone's sovereign debt crisis.
U.S. crude for February delivery settled down $1.92 at $88.38 a barrel in a second straight day of heavy volume.
Prices hit $92.58 on Monday, the first trading day of the year.
As of 3:25 p.m. EST (2035 GMT), crude oil volume on the New York Mercantile Exchange hit 972,774 lots, 6.7 percent above Wednesday's level and 74 percent above the 30-day average, according to preliminary Reuters data.
In London, ICE Brent crude for February ended 98 cents lower at $94.52.
Brent's premium to U.S. crude touched $6.55 , the widest level since it hit $6.57 on May 13, 2010. If the spread pierces that seven-month high, it would be the widest spread since Feb. 12, 2009, when it dropped below $10 on an intraday basis.
Brent's strength has been spurred by continued strong Asian demand and robust European product markets, while U.S. crude has been pressured by an extended build in stockpiles at the key delivery hub in Cushing, Oklahoma, despite a drop in national stocks over the last five weeks.
"An influx of Canadian crude is finding its way into the Cushing region and is likely to translate to a record supply at the futures delivery point with next week's data release," said Jim Ritterbusch, president of Ritterbusch & Associates in Galena, Illinois.
Concerns about the Eurozone economy have undermined the single European currency which fell 1 percent to a five-week low against the dollar on Thursday. Across the Atlantic, there is renewed optimism amid recent signs that the U.S. recovery is moving at a faster pace.
In late trading, the U.S. dollar was up 0.74 percent against a basket of currencies.
"It's all about the dollar strength and if the dollar keeps rising you could see more profit-taking up here at these levels," said Richard Ilczyszyn, senior market strategist at Lind-Waldock in Chicago.
Dollar-denominated commodities become more or less expensive for nondollar buyers depending on the relative strength of the U.S. currency.
Revised forecasts in a Reuters poll showed expectations that nonfarm payrolls jumped 175,000 after November's small gain of just 39,000.
Unemployment was forecast to have edged down to 9.7 percent last month, from 9.8 percent in November.
In the face of that forecast, uncertainty dogged financial and commodity markets as the day's report of a rise in new jobless benefit claims contrasted with Wednesday's data showing a surprisingly big jump in private sector jobs.
U.S. claims for unemployment benefits rose more than expected last week, adding to bearish sentiment, even though the four-week average, considered a better gauge of underlying labor trends, declined to a 2-1/2 year low.
Analysts said there could be some price distortion this week as the big investment indexes rebalance their crude futures weightings.
"The rebalancing period is well flagged and as such, some of the recent moves in the market are likely to reflect the anticipated rebalancing to some extent," said James Zhang, an analyst at Standard Bank Commodities Research.