ANALYSIS - Dollar trouble, oil's bubble could derail recovery

By Wanfeng Zhou and Barani Krishnan

NEW YORK (Reuters) - The weakness in the U.S. dollar risks inflating a bubble in the oil market, which could threaten consumer spending and potentially cause a double dip recession.

The greenback's decline this year has been lauded as good for America as it benefits earnings, stimulates exports and helps rebalance the U.S. economy. But runaway oil prices could be the Achilles' heel to the thesis that sees only a benign impact of a weak dollar.

This year, when the dollar has been weak, oil has been strong; a weaker dollar supports oil because dollar-priced commodities become cheaper for buyers using other currencies. The inverse relationship between the dollar and crude has been remarkably tight: the 200-day correlation coefficient between the dollar index and oil is -0.94, Reuters data showed.

In some respects, this is a repeat of last year when a weak dollar, along with low interest rates and growth in energy-intensive Asia, drove oil to a record near $150 a barrel, which contributed to a deep global recession.

"Many factors are the same as the summer of 2008," said Ethan Harris, head of global economics at Bank of America Merrill Lynch in New York. "What are the things that would derail the recovery? I think that an oil price bubble is near the top of the list."

There's a reason for fear of excessively high oil prices. Rising energy costs caused consumers to curtail spending in mid-2008, even before the financial crisis erupted, and another spike could sap demand anew, especially with this economic rebound still a fragile one.

The dollar has dropped 15 percent against a currency basket since highs set in March. Crude , meanwhile, has rebounded from lows around $30 a barrel early this year to top $80 in recent weeks.

Another drop in the dollar toward $1.60 per euro could help push oil back above the $100 level. That's enough to cause economic stress given the still-fragile state of global recovery, analysts say.