(Reuters) - Brent crude reversed early losses and climbed towards $104 per barrel on Thursday, but a bleak demand outlook as the euro zone debt crisis grinds on kept gains in check and set prices up for their biggest monthly percentage drop in two years.
A rebound in the euro gave a modest boost to oil and other commodities in afternoon trading in Asia, although the gains are likely to be short-lived given the debt crisis in the single currency bloc.
Surging borrowing costs for Spain and Italy and signs that Greece's anti-austerity parties were gaining in opinion polls ahead of elections in June muddied the demand outlook for commodities, forcing investors to cash out.
The situation in Spain at the moment is untenable, not only is there concern over the state of its banking sector but there is little confidence its government will actually be able to bail them out, said Michael Creed, an economist at the National Australia Bank.
London Brent crude for July delivery was up 29 cents at $103.76 per barrel by 0747 GMT, recovering from a low of $102.90 to hit a high of $103.96 earlier in the session.
But prices were on track for a more than 13 percent loss this month, the biggest since May 2010.
U.S. crude for July delivery was up 7 cents to $87.89 per barrel. Prices were headed for a steep loss of more than 16 percent this month - the worst since late 2008.
Fear has definitely got the market around its little finger today. The Spanish Flu has set in as Spanish 10-year bond spreads blow out over the German 10-year, Ben Taylor, a trader at CMC Markets, said in a note to clients.
The current spread is non-sustainable and it's widely assumed that a Spanish bailout is now likely.
Risk aversion gripped financial markets across the board, with Asian equity markets sliding as problems in Spain and fears of a messy Greek exit from the single currency bloc raised contagion fears.
A caution by Spain's central bank governor that Madrid may miss deficit targets this year pushed Spanish 10-year yields close to 7 percent, a level seen as unsustainable and which could lead Spain to seek a bailout.
Frankly I'm not sure if there is enough in the bailout fund to cover the Spanish banks, Creed said.
We need to see the European Central Bank taking a more proactive stand in this kind of environment, the market needs reassurance.
Adding to the nervousness in markets, the latest polls from Greece showed parties for and against a bailout neck-and-neck ahead of a June 17 election that may decide whether Greece remains in the euro.
U.S. CRUDE INVENTORY
U.S. crude prices have been weighed down by a climb in domestic oil stockpiles. In the nine weeks to May 18, crude inventories have risen 36 million barrels, data from the U.S. Energy Information Administration (EIA) showed, the largest nine-week stock build on record.
According to a Reuters poll, stockpiles are expected to see a 10th consecutive weekly rise for the week to May 25.
Data released by the American Petroleum Institute late Wednesday showed an unexpected 353,000 barrel drawdown for last week. The market is now eyeing data from the U.S. EIA scheduled for release later in the day.
(Editing by Himani Sarkar)