Oil settles at 2-1/2 year high near $107

NEW YORK (CNNMoney) -- Oil prices settled at a two-and-a-half-year high Thursday, rising 2.4% to end near $107 a barrel, as the U.S. dollar weakened and turmoil in the Arab world continued to stoke supply concerns.

The main U.S. oil contract, West Texas Intermediate, for May delivery added $2.45 to end at $106.72 a barrel. Brent crude, the European benchmark, rose $2.12 to $117.25 a barrel.

The rally came as the dollar fell 0.6% against the euro on speculation the European Central Bank is poised to raise interest rates to ward off rising inflation.

Eurostat, the European Union's statistics agency, estimated Thursday that euro area inflation rose 2.6% in March, up from 2.4% in February.

While inflation has also ticked higher in the United States, the Federal Reserve is not expected to raise interest rates soon, even as the central bank signals an end to its asset purchase program.

The different approaches to monetary policy could set the stage for a period of prolonged dollar weakness, traders said, since it would revive the so-called carry trade.

The carry trade is when investors use the currency of a country with low interest rates to fund investments in countries with higher rates. It tends to push the target currency, in this case the dollar, lower in the market.

"Right now the market is focused on the idea that a rate increase in Europe is imminent," said Phil Flynn, senior market analyst at PFG Best. "The weaker dollar is bullish for commodities, and that's what really gave us the boost."

Crude oil, which is priced in the U.S. currency, often rises when the dollar declines. A weaker greenback makes oil a more attractive investment for buyers in other currencies.

Meanwhile, oil prices are on track to end the first quarter with gains of nearly 16% as the conflict in Libya and political strife in the Middle East continue to raise concerns about supply disruptions.

The jump in oil prices has driven retail gasoline prices sharply higher. The national average price for a gallon of regular gas rose to $3.606 as of Thursday, according to a daily survey from motorist group AAA.

That's up 1.1 cents from Wednesday and the ninth consecutive daily increase. Gas prices rose nearly 54 cents on average in the first quarter, with drivers in some states paying over $4 a gallon.

Oil prices first rose above $100 a barrel in February as protesters in Egypt and Tunisia pushed out unpopular leaders. Prices rose even further as the unrest led to civil war in Libya, which has curtailed output in the Africa's third largest oil producer.

The popular movement has also roiled governments in strategically important Middle Eastern nations such as Syria, Yemen and Bahrain.

The concern is that the situation in those countries, where government forces have cracked down violently on protesters, could devolve into something similar to Libya.

Oil prices eased somewhat following the March 11 earthquake and tsunami in Japan. The disaster and ensuing nuclear crisis has clouded the outlook for the world's third largest economy, raising questions about short-term energy demand in Japan.

Still, the outcome for Libya remains far from certain and traders expect the oil market to remain volatile until the situation there is resolved.

"Libya is not going away overnight," said Flynn. "It's a long term situation and that uncertainty is putting upward pressure on the market."