(Updates prices)
By Alex Lawler and Santosh Menon
LONDON, July 23 (Reuters) - Oil dipped below $127 a barrel on Wednesday, falling for a second straight session, as concern eased that Hurricane Dolly would hit Gulf of Mexico crude supply.
The slowing U.S. economy and lacklustre energy demand in the world's top consumer also weighed on the market, analysts said. Attention later on Wednesday will focus on the latest weekly U.S. inventory report.
"Dolly has not deviated much from its forecasted path," said Olivier Jakob, oil analyst at Petromatrix. "Its price impact potential should now be discounted."
By 1255 GMT, U.S. crude <CLc1> for September was down $1.63 at $126.79, having fallen as low as 125.35, the lowest since June 5.
Brent crude <LCOc1> was $1.64 lower at $127.91.
Oil's further drop coincided with a firmer dollar, which may have reduced the appeal of commodities to some investors, analysts said. The dollar hit a one-month high against the yen on Wednesday.
Analysts who chart past price movements to predict future direction said the market could head lower for now, given that the next area of support is around $120 to $122 a barrel for U.S. crude.
"In addition to Dolly's likely fade into oblivion, we suspect that crude's technicals are not helping matters much either," analysts at MF Global said in a report.
Even after its pullback from the July 11 record high of $147.27, oil has rallied almost 30 percent in 2008 and is up from $20 in early 2002, driven by demand from fast-growing economies like China.
The high prices have started to dent demand by contributing to a slowdown in global economic growth and changing habits of consumers such as U.S. car drivers.
Hurricane Dolly was still expected to come ashore well away from the key offshore platforms, even after it was upgraded to the Atlantic season's second hurricane late on Tuesday.
Oil companies working in the U.S. Gulf of Mexico shut 5 percent of oil and natural gas output by Tuesday but those outages were expected to be short-lived. [
]Later on Wednesday, the latest U.S. inventory report is expected to show crude stocks fell by 700,000 barrels, while stocks of distillates rose by 2.3 million barrels, according to a Reuters poll [
].Last week crude inventories were also forecast to have fallen, only for the data to show that they had increased substantially, helping to push prices lower.
"After last week's surprisingly large crude oil stock build, we have to expect to see a draw this week," said Peter Beutel, president of Cameron Hanover in Connecticut.
The U.S. Energy Information Administration will release its inventory data for the week to July 18 at 1435 GMT. (Reporting by Annika Breidthardt and Alex Lawler, editing by Anthony Barker)