LONDON (AFP) — Oil prices shot higher on Tuesday after the Federal Reserve slashed three-quarters of a point off interest rates, fueling expectations of stronger energy demand from the world's biggest economy.

The bold Fed action, though widely expected, signaled relief to markets worried about a potential meltdown of the global financial system two days after the central bank engineered a rescue of Bear Stearns, one of the largest US investment banks.

New York's main oil contract, light sweet crude for delivery in April, climbed 3.30 dollars to close at 109.42 dollars a barrel.

In London, Brent North Sea crude for May jumped 3.81 dollars to settle at 105.56 dollars.

The two benchmark contracts had hit record peaks on Monday -- 111.80 dollars in New York and 107.97 in London -- before closing lower as traders fretted that the fallout from rising financial market turmoil would curb energy demand.

The Fed on Tuesday lowered its base federal funds rate to 2.25 percent from 3.0 percent in a bid to stimulate sluggish economic growth and stave off a global credit crunch that is threatening to cripple the financial system.

"Previous rate cuts have fueled inflation concerns, and investors have moved money into the commodity complex in record fashion," said Eric Wittenauer, an analyst at AG Edwards.

While few analysts are predicting oil prices to retract at the moment, most energy experts agree that the oil market fundamentals do not support such an expensive price.

"Crude oil remains focused on the weak dollar and inflation stories although we see a large bearish divergence between the resulting rise in oil prices and the deteriorating underlying fundamentals," said Citigroup analyst Tim Evans.

Oil prices on Tuesday have benefited from general dollar weakness, which made commodities priced in the greenback cheaper for those trading in stronger currencies.

Meanwhile, higher equity markets boosted sentiment and meant players did not need to sell commodities in a bid to raise cash and cover losses, as was the case Monday.

Markets have improved on decent first-quarter results from Goldman Sachs and Lehman Brothers.

Sentiment towards commodities, in recent months, has tended to shift two ways, analysts said.

Either market players buy commodities and trade on the notion that they are a safe bet in times of economic crisis as raw materials, supported by a tight supply/demand balance, and will hold their value -- or they sell commodities when equity markets crash to raise cash and cover their losses.

Looking ahead, any sharp movements on the equity markets are likely to drive the oil price.

On the fundamental side, the US will release weekly inventory figures on Wednesday. But the data might go unnoticed, as oil prices continue to be driven by fund sentiment, rather than supply issues, analysts said.