UPDATE 3-Brent falls below $109 ahead of Cyprus bailout vote
* Cyprus expected to reject on bank deposits levy on Tuesday
* EU urges Cyprus to spare smaller savers from levy
* Investors eye Fed policy meeting for QE status
* Coming Up: API weekly oil inventories data; 2030 GMT
(Updates throughout, changes dateline, previous SINGAPORE)
LONDON, March 19 (Reuters) - Crude oil fell below $109 a barrel on Tuesday as uncertainty over a bailout for Cyprus revived concerns about the euro zone debt crisis, but a rosier economic outlook in the United States capped losses.
Cyprus's parliament was set to reject a divisive tax on bank deposits in a vote on Tuesday, pushing the island closer to a debt default and banking collapse. The proposal announced over the weekend shattered calm in the euro zone and caused global markets and the euro to tumble on Monday.
The move sparked concerns of a run on banks elsewhere in the euro zone and worries that similar extraordinary measures might be taken if other indebted member states need funding help. Such a scenario would weaken demand for oil from the euro zone.
"The situation in Cyprus, although small, goes to show that the problems in the EU are far from over and it will exacerbate the declining demand within EU, keeping a lid on oil prices if not pushing them down," said Natixis analyst Abhishek Deshpande in London.
"If a deal is reached, we should see oil prices rise slightly or even remain unchanged... but if there is no deal, then the chances of Cyprus leaving the EU still could be high, and we could potentially see prices slide back further."
Brent crude for May delivery was down 70 cents at$108.81 a barrel by 0930 GMT. It briefly hit a three-month low on Monday before settling 31 cents lower. U.S. crude for April was down 5 cents at $93.69.
Late on Monday, the decision by euro zone finance ministers to give Cyprus more flexibility over a levy on bank deposits, that is part of the bailout conditions, partially restored confidence.
"It's an over reaction from a complacent investor crowd," Gordon Kwan, head of energy research at Mirae Asset Securities in Hong Kong, told the Reuters Global Markets Forum.
"Expect oil prices to rebound once there are better economic headlines emerging from China and the United States. The ECB will make sure that this Cyprus contagion will not spread and is a one-off."
In the United States, investors looked ahead to a Federal Reserve policy meeting for any indication of whether it would scale back its monetary expansion as the economy shows signs of improvement. Almost all U.S. states began 2013 with lower unemployment rates than at the start of 2012, Labor Department data showed on Monday.
"It will be business as usual (in the United States). We don't expect any changes or scale back by Fed especially during such turbulent environment in Europe," Deshpande at Natixis said.
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Investors will also watch U.S. oil inventories data due on Tuesday and Wednesday for a further fall in crude stocks at oil futures delivery hub Cushing, Oklahoma, that could strengthen West Texas Intermediate (WTI) prices against Brent.
"A Cushing stock draw will raise confidence that the glut in Cushing is alleviated," Nunan said. "The WTI/Brent spread is going to narrow in the long run."
Brent's premium to WTI for May <CL-LCO1=R> is about $15 a barrel, down from more than $20 in February.
U.S. commercial crude stockpiles are expected to have risen 2 million barrels last week amid low refinery runs, a preliminary Reuters poll of analysts showed on Monday.
Distillate inventories are likely to have fallen 1.2 million barrels, while gasoline supplies are seen down 2.5 million barrels, the poll showed.
(Additional reporting By Florence Tan in Singapore; editing by Jason Neely)