Oil prices dropped more than 2 percent on Tuesday as an interest rate increase by India added to concerns about demand and gains in the dollar helped spark a technical sell-off.

Brent crude broke under the 20-day moving average that had helped support prices since November, sparking technical selling as the dollar rebounded and briefly turned higher against the euro.

The dollar index <.DXY>, which tracks the greenback against a basket of currencies, seesawed as it tried to recover from a three-year low and its late strength weighed on oil.

The slide in oil has come in response to equities losses and the dollar entering positive territory, said Matt Smith of Summit Energy in Louisville, Kentucky.

There was a bit of euphoria in equities markets yesterday following (Osama) bin Laden's death. Today the focus has returned to risk aversion and the economy.

Oil's negative correlation with the dollar -- a trade in which investors shift cash between the greenback, crude and other commodities as risk aversion rises and falls -- hit the highest level since late November.

Brent crude for June fell $2.67 to settle at $122.45 a barrel. U.S. crude for June dropped $2.47 to settle at $111.05 a barrel. Both contracts posted the biggest two-day percentage declines since April 12.

Oil's late slide added to earlier losses sparked as India's central bank raised interest rates more than expected, which could curb demand growth.

There are concerns that higher interest rates could be a growth killer and that could be what is weighing down oil prices. India is one of the biggest emerging economies where a lot of global growth will come from, said Michael Hewson, an analyst at CMC Markets.

Brent trading volumes rebounded after being dampened by a holiday in Britain. U.S. trading volumes were on pace to total about half a million lots, near the 30-day average.

Traders also eyed news that China's state oil giants PetroChina <0857.HK> and Sinopec <0386.HK> had asked the government to cut a fuel consumption tax to reduce their refining losses.

China, the world's No. 2 oil consumer, has recently taken action, including raising interest rates and bank reserve requirements, to try to slow inflation and cool its economy.

RISING U.S. INVENTORIES

U.S. crude oil stocks rose 3.2 million barrels last week, the industry group American Petroleum Institute said in a report released late on Tuesday.

Gasoline stocks rose 680,000 barrels, but distillate inventories fell 1.5 million barrels, the API said.

Ahead of the API report, a Reuters survey of analysts yielded a forecast for crude stocks to be up 2 million barrels, with gasoline stocks seen up 300,000 barrels and distillates up 600,000 barrels.

Crude prices extended losses slightly in post-settlement trading after the API report, but did not extend trading ranges.

The U.S. Energy Information Administration's report follows on Wednesday at 10:30 a.m. EDT (1430 GMT).

The U.S. average gasoline price hit $3.96 a gallon, up 8.4 cents in the latest week, according to the Energy Department. Weekly data from MasterCard Advisors' SpendingPulse report showed gasoline demand dipped 0.6 percent from year-ago levels last week.

(Additional reporting by David Sheppard and Gene Ramos in New York, Alex Lawler and Claire Milhench in London and Francis Kan in Singapore; editing by Dale Hudson and David Gregorio)

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