By Christopher Johnson

LONDON | Thu Aug 26, 2010 9:29am EDT

LONDON (Reuters) -

Oil rose for a second day on Thursday following better-than-expected U.S. unemployment data and a fall in the dollar as investors moved back into the market after it recovered from 11-week lows.

New U.S. claims for unemployment benefits fell more that expected last week, government data showed on Thursday. Initial claims for state unemployment benefits fell 31,000 to a seasonally adjusted 473,000 in the week to August 21.

Gold fell and the dollar erased some losses after the jobs data while U.S. oil prices added an extra 30 cents to its earlier gains before slipping back.

Benchmark U.S. crude futures for October traded at $72.87, up 35 cents per barrel, by 1320 GMT after reaching a high of $73.76, up $1.24. The contract rose more than 1 percent on Wednesday after touching $70.76, its lowest since early June. Oil has dropped about $10 from a peak of almost $83 on August 4.

ICE Brent climbed $1.07 to $74.55.

"The market has been discounting another dip in the U.S. economy recently and has been oversold," said Eugen Weinberg, commodity analyst at Commerzbank in Frankfurt. "Today's jobs data is better than expectations and there is also some bargain-hunting after the recent price falls."

The rally was supported by a 0.3 percent fall in the value of the dollar .DXY against a basket of currencies. A weaker dollar often supports commodities because many of them are priced in the U.S. currency.

Equity markets were also stronger. .N .EU .HK

Front-month U.S. crude futures' 14-day relative strength index (RSI) fell to just 30 on Tuesday, a technical pointer to oversold conditions, but has since bounced to around 40, Reuters data show, partly on profit-taking from short positions.

GLOOMY

But the supply and demand picture for oil remained negative and the wider economic picture was also gloomy, leading some analysts to suggest the rally could be short-lived.

"This has all the hallmarks of an upside correction or retracement in an otherwise falling market," brokers at PVM Oil Associates in London said.

Financial markets awaited U.S. second-quarter gross domestic product due for release on Friday.

New U.S. home sales slumped to their slowest pace on record in July and orders for costly durable goods were weak, data showed on Wednesday, heightening fears the economy was at risk of another downturn.

A slowdown in the manufacturing sector as indicated by the weak U.S. durable goods orders report "does not offer much hope for a bounce in diesel demand heading into September," Harry Tchilinguirian, strategist at BNP Paribas, said in a note.

"Similarly, labor markets offer scant support to gasoline demand, and with the end of the driving season around the corner, seasonal support will begin to fade," he added.

A negative underlying mood also prevailed in the oil market after government statistics showed total U.S. oil stocks rose to a fresh all-time high last week, with gains across the board.

The U.S. Energy Information Administration said on Wednesday U.S. crude inventories rose by a bigger-than-expected 4.11 million barrels last week.

Gasoline inventories were 2.27 million barrels higher, while distillate stocks, which include heating oil and diesel, increased by a larger-than-expected 1.76 million barrels.

In aggregate, commercial crude and product stocks rose to 1.139 billion barrels last week, topping the record weekly high of 1.13 billion barrels set in the week to August 13.

"The United States is filled-up to the rim on product stocks," said Olivier Jakob, consultant at Petromatrix in Zug, Switzerland. "The U.S. stock levels are so high that it is difficult to price any risk premiums. At current stock levels, (even) a hurricane will not be difficult to manage."

(Additional reporting by Alejandro Barbajosa in Singapore; editing by Alison Birrane)