Oil falls more than 3 percent; energy drags down stocks

By Caroline Valetkevitch

NEW YORK (Reuters) - Oil prices dropped more than 3 percent on Wednesday following a surprise increase in gasoline inventories, and declines in energy shares weighed on U.S. stocks.

The dollar recovered from recent weakness against the euro (EUR=) and the safe-haven yen (JPY=), while sterling was off six-month highs hit after Britain's prime minister on Tuesday called for a snap election.

Investors also braced for the coming French election. Four days before the first round of the presidential election in France, just a few points separate the top four candidates, including two who oppose the euro - the far-right's Marine Le Pen and the far-left's Jean-Luc Melenchon, according to opinion polls.

In the oil market, the counter-seasonal build of 1.5 million barrels in gasoline in the latest week, along with an increase in U.S. production, pressured prices.

U.S. crude futures (CLc1) fell 3.8 percent to settle at $50.44, while Brent crude futures (LCOc1) dropped 3.6 percent to $52.93.

The oil losses hurt shares of U.S. energy companies, pushing the S&P 500 energy index (.SPNY) down 1.4 percent and causing the benchmark S&P 500 (.SPX) index to reverse earlier gains.

"Crude broke $52 on WTI, that is the strongest correlation we have right now away from the case-by-case earnings we have," said Art Hogan, chief market strategist at Wunderlich Securities in New York.

U.S. first-quarter earnings so far have been mostly stronger than expected. On Wednesday, shares of Morgan Stanley (MS.N) rose 2 percent following the bank's results, though International Business Machines (IBM.N) dropped 4.9 percent and pressured the Dow.

The Dow Jones Industrial Average (.DJI) was down 118.79 points, or 0.58 percent, to 20,404.49, the S&P 500 (.SPX) lost 4.02 points, or 0.17 percent, to 2,338.17 and the Nasdaq Composite (.IXIC) added 13.56 points, or 0.23 percent, to 5,863.03.

The pan-European STOXX 600 index (.STOXX), which hit a three-week low on Tuesday, ended up 0.2 percent.

In the U.S. Treasury market, bond yields rose after a rally on Tuesday sent yields to five-month lows prompted by concerns about the French election and rising geopolitical tensions.

Benchmark 10-year notes dropped 8/32 in price to yield 2.21 percent. The 10-year yield fell as low as 2.165 percent on Tuesday; it has tumbled from a high of 2.63 percent reached on March 14.

Questions still hung over the "reflation" trades that had lifted markets since Donald Trump became U.S. president. A run of disappointing U.S. economic data and doubts the Trump administration will progress with tax cuts have quelled expectations of faster inflation.

STERLING EASES

Sterling was down 0.19 percent at $1.2811. It hit a six-month peak against the dollar (GBP=D3) on Tuesday following British Prime Minister Theresa May's call for an early general election on June 8, seeking to strengthen her party's majority ahead of Brexit negotiations.

Britain's FTSE 100 (.FTSE) index fell 0.5 percent.

British stocks are vulnerable to a rising pound because more than two-thirds of FTSE 100 company earnings are derived from operations overseas.

The greenback was 0.54 percent higher against the yen and up 0.17 percent against the euro.

Gold dropped 1 percent as the dollar gained, with spot gold (XAU=) falling as low as $1,275.73 per ounce.

(Additional reporting by Jamie McGeever in London and Chuck Mikolajczak and Julia Simon in New York; Editing by Nick Zieminski)