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LONDON (Thomson Financial) - Oil fell sharply as worries that a looming US recession will crimp demand combined with improved supply side news in the form of better than forecast increases in US energy inventories.

The US Energy Information Administration said earlier US crude stocks rose by 7 mln barrels last week to total 300 mln barrels. Analysts were expecting stocks to rise by only 2.07 mln barrels

Meanwhile gasoline stocks rose by 3.6 mln barrels last week against forecasts for a 1.7 mln barrel rise, while distillate inventory grew by 0.1 mln barrels against calls for a 1.9 mln barrel decline.

"The major figures were all bearish relative to expectations... About the only supportive element is the drop in refining rates, but no one will care when product stocks are rising," said Citigroup analyst Tim Evans.

At 4.06 pm, New York's WTI crude for March delivery was down 1.03 usd at 87.38 usd per barrel, having dropped 1.61 usd to close at 88.41 usd yesterday.

In London, Brent crude for March delivery was down 68 cents at 88.14 usd per barrel.

Prices were steady before the data release, recouping some of yesterday's losses as players scaled back bets on rising US energy inventory and took the view yesterday's selling was overdone.

However, with US energy inventories clearly on the rise and recession fears still at heightened pitch, there is little to tempt players back to the market on the buy side.

"Sharp declines in the service sector indices in both the US and Europe suggest a further deterioration in the global economic condition, with a subsequent drop in demand being a given for the energy markets," said MF Global analyst John Kilduff.

Yesterday, data from the Institute of Supply Management showed activity in the US services sector slumped to its worst level since March 2003. And in the Eurozone, the PMI services reading plunged to its lowest since July 2003.

Kilduff said the data shows "the economic tumour is clearly metastasizing", threatening oil demand at a time when "supplies have apparently begun to replenish".

Oil prices have now fallen more than 12 pct off a record 100.09 usd set in early January, and many analysts are for now ruling out the upside and instead trying to pick a near term floor in prices.

They note that while the economic contagion from the US has only infected Europe so far, there are possible problems on the horizon in emerging economies also.

China is currently grappling with power shortages that have been exacerbated by the worst winter storms in decades. In addition, it might yet soon have to contend with softness in its export markets.

"What is making the slowdown in the US even more painful is that it is starting to spread... Short term we believe we are on track to test key support at 85.82 usd level basis March WTI," said MF Global analyst Ed Meir.

Should this support level be broken, it would constitute a technical break of the longer term uptrend that has been in place since January 2007, noted Meir, who believes such a scenario is likely.

Looking ahead, it is as yet unclear whether OPEC will attempt to support oil prices by cutting output at its production meeting next month. The cartel has so far resisted such moves.

Yesterday, OPEC Secretary General Abdalla El-Badri said the cartel will roll over production quotas in March if market conditions remain as they are currently.

Others in the cartel have indicated otherwise, however.