Oil futures rallied yesterday, pushing briefly past US$101 a barrel after the Federal Reserve lowered its forecast for economic growth this year, convincing energy investors that the central bank will slash interest rates further. At the pump, meanwhile, gas prices rose another two cents overnight.

The Fed said damage from the housing slump and problems in the credit markets will slow economic growth to between 1.3 per cent and two per cent this year, down from a previous forecast for growth of 1.8 per cent to 2.5 per cent.

Oil investors can interpret such news in one of two ways: selling on concerns that the economy, and thus demand for oil, is cooling; or buying on the prospect that interest rates will fall, weakening the dollar and feeding new buying of oil futures. On Wednesday, they definitively chose the latter view.

The Fed was “the catalyst to get us going here,” said Phil Flynn an analyst at Alaron Trading Corporation in Chicago.

The contract for March delivery of light sweet crude, which was expiring later yesterday, rose 73 cents to settle at US$100.74 on the New York Mercantile Exchange after earlier rising as high as US$101.32, a new nominal high, though short of an inflation-adjusted record. On Tuesday, the contract jumped $4.51 a barrel.

Falling rates tend to weaken the dollar, and crude futures offer a hedge against a falling dollar. Also, oil futures bought and sold in dollars are more attractive to foreign investors when the dollar is falling. In the moments after the Fed released its forecast, oil prices spiked sharply higher.

“This is unbelievable,” Flynn said.

Earlier, crude prices fluctuated in part because of low trading volumes.

Oil prices are still within the range of inflation-adjusted highs set in early 1980. Depending on how the adjustment is calculated, $38 a barrel then would be worth $96 to $103 or more today.

Two new economic reports yesterday suggested the economy is cooling.

The Labour Department said its Consumer Price Index, a measure of inflation, rose by 0.4 per cent last month, more than economists expected.

The Commerce Department, meanwhile, said construction of new homes and apartments rose by 0.8 per cent in January, but that applications for building permits, an indicator of future activity, fell by three per cent.

The reports come a week after the Energy Department, the Organization of Petroleum Exporting Countries and the International Energy Agency all lowered their oil demand growth forecasts for this year.

But the prospect that the Fed will reduce rates proved too strong, feeding a new buying frenzy, analysts said.

“This is all about momentum,” driving prices higher right now, Flynn said. Despite the return of US$100 oil, there are also concerns that high oil prices — and the higher gasoline and heating oil prices they spawn — are sowing the seeds of their own destruction by contributing to the economic slowdown.

“The price gains raise questions about their sustainability in the face of eroding fundamental strength,” said Antoine Halff an analyst at Newedge USA LLC, in a research note.