Oil rose over 2 percent on Monday as stronger U.S. manufacturing data prompted optimism about economic recovery and a weaker dollar helped boost crude demand after oil prices fell to five-week lows on Friday.

An industry report showed the U.S. manufacturing sector grew in January at a faster rate than expected, in a sixth straight month of expansion.

The Institute for Supply Management (ISM) index rose to its highest since August 2004, a sign the world's top economy is recovering from the deepest recession in decades, which could boost oil demand.

U.S. crude for March delivery settled up $1.54 at $74.43 a barrel. Prices touched $72.43 on January 29, their lowest level since December 21. London Brent crude rose $1.65 to $73.11.

Oil prices fell more than 8 percent in January, pressured by weak energy demand in the United States, worries about fiscal turmoil in smaller euro zone countries and a stronger U.S. dollar.

A weaker dollar, growth in consumer spending and firming equities markets helped to push oil prices higher on Monday, as optimism surrounding a U.S. recovery prompted investors to funnel more money into assets considered riskier, such as commodities and stocks.

The (oil) market flushed out strongly last week, but now we are starting to see some support for prices, said Gene McGillian at Tradition Energy in Stamford, Connecticut. The ISM number, a rise in equities and the dollar's slight weakening all support oil prices.

Oil prices often rise when the dollar weakens since it makes the dollar-priced commodity cheaper for holders of other currencies, boosting demand.

The dollar came under pressure on Monday after news that U.S. President Barack Obama expected the U.S. budget deficit would soar to a record in 2010. The U.S. Commerce Department reported that consumer spending rose a quicker-than-expected 0.2 percent in December.

U.S. stocks rose after Exxon Mobil , the largest U.S. oil company, reported a better-than-expected 23 percent decline in its fourth-quarter profit.

Royal Dutch Shell said on Sunday it had shut in some crude production in Nigeria, a key African exporter, after a crude oil pipeline was sabotaged over the weekend.

U.S. crude oil inventories likely slipped slightly last week, according to a preliminary Reuters analyst survey on Monday. Crude inventories likely fell 200,000 barrels in the week, according to the average estimate of nine analysts.

Temperatures in the U.S. Northeast, the world's biggest market for heating oil, are expected to be mostly below normal through mid-February, according to the National Weather Service.

Analysts warned any rebound in oil prices may still be short-lived, since demand for crude in the United States still has not rebounded strongly since the recession, prompting the U.S. refining industry to run its plants near the lowest rates since the 1980s.

U.S. stocks of distillate fuel, such as heating oil and diesel, were 16 percent above five-year averages in late January, according to government data.

This is not a trend higher but a reaction after three weeks of falls. The fundamentals have not improved. The market is still over supplied and demand is not there yet, said Eugen Weinberg, commodities analyst at Commerzbank in Frankfurt.

(Additional reporting by Christopher Johnson in London and Fayen Wong in Perth; Editing by Marguerita Choy)

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