Oil falls as Fed measures fail to boost risk assets

Motorists queue up for gas at a service station in Port of Spain August 24, 2011.

NEW YORK (Reuters) - Oil prices ended lower on Wednesday after the U.S. Federal Reserve said the economic outlook remained grim, which overshadowed an unexpectedly steep drop in crude supplies in the world's top oil consumer.

Brent for November delivery fell 18 cents a barrel to settle at $110.36, after topping $112 earlier. U.S. crude settled $1.00 lower at $85.92 a barrel after rising as high as $87.99.

Oil prices had risen in earlier trade after government data showed U.S. crude inventories last week dropped 7.3 million barrels, the biggest one-week drop since December, suggesting supplies were tighter than expected.

But the market turned bearish after the Fed said it would extend the maturity of its treasury holdings but didn't unveil more aggressive measures to boost a U.S. economy it said faces "significant downside risks".

The Fed plans to extend the maturity of its treasuries, buying $400 billion in long-term notes, while selling an equal amount of bonds maturing in three years or less by mid-2012, the central bank's market committee said.

The Fed said it discussed a variety of other "policy tools" it could use to promote stronger economic growth, but its statement stopped short of announcing any more measures.

Previous efforts by the Fed to stimulate a flagging U.S. economy have resulted in more buying of risk assets including commodities and equities, but some analysts said the Fed's latest plans aren't aggressive enough to warrant that.

"In lieu of a third round of quantitative easing, which could have boosted confidence .... the Fed implemented "Operation Twist," said Jason Schenker of Prestige Economics in Austin, Texas.

"The actual FOMC announcement contained no real stimulus."

The latest Fed package is an effort to tweak its $2.85 trillion balance sheet and put more downward pressure on long-term interest rates over time to help the battered U.S. housing sector and encourage more hiring.

But Fed policymakers said the labour market remained weak.

"Recent indicators point to continuing weakness in overall labour market conditions, and the unemployment rate remains elevated."

After the statement, major U.S. stock indexes fell further and the U.S. dollar trimmed losses against the euro.

"The dollar gained and that caused oil to slip. The market took it as bearish for oil. The language used to discuss the economy was not encouraging," said Chris Dillman, analyst at Tradition Energy in Connecticut.

(Additional reporting by Robert Gibbons and Janet McGurty in New York, and Alex Lawler and Simon Falush in London; Editing by Marguerita Choy)