UPDATE 8-Oil rises nearly $2 to 2014 high on spread trade

* Brent-WTI spread narrows to $10

* U.S. crude inventories seen up, distillates down -poll

* API weekly oil data due 4:30 p.m. EST (2130 GMT)

NEW YORK, Jan 28 (Reuters) - U.S. oil rose nearly $2 on Tuesday, settling at its highest price this year and narrowing its discount to European Brent, as traders expected data to show supplies were draining from the contract's benchmark delivery point.

Market perception that the gradual startup of TransCanada Corp's Keystone pipeline would move supplies from oil hub Cushing, Oklahoma, where the U.S. crude oil contract is priced, to the Gulf Coast supported prices.

A lack of pipelines in the region has kept U.S. prices depressed relative to Brent oil for the past three years.

"The Brent/WTI spread is contracting a bit more, and that always helps crude prices," said Tariq Zahir, managing member of commodity trading advisor Tyche Capital Advisors in New York. "The market is expecting a little bit more of a draw at Cushing since that pipeline has opened up. It's a volatile trade."

Brent oil also rose, but not as high, reversing losses on Monday spurred by concerns over emerging markets and the perception of a slowing economy in China.

Brent crude touched a high of $107.79 a barrel, up $1.10, and then settled up 72 cents at $107.41 a barrel. On Monday, Brent fell $1.19, its biggest loss since Jan. 2.

U.S. light crude oil touched a high of $97.66, up $1.94, and settled $1.69 higher at $97.41, its highest settlement since Dec. 31.

The spread between the two benchmarks narrowed by as much as $1.20 to $9.77 on Tuesday before settling at $10.

Also lending support to the market was strong economic data from the United States, the world's largest oil consumer. Consumer confidence hit a five-month high in January and a key index of house prices increased 13.7 percent in November from a year earlier, the largest rise since February 2006.

Those two pieces of data seemed to overshadow a poor durable goods report, which showed orders for long-lasting U.S. manufactured goods dropped 4.3 percent in December.

U.S. crude was also supported by analysts' projections for a drop in distillate inventories, including heating oil and diesel fuel, as demand rose over a brutally cold winter across the Northern Hemisphere.

Front-month U.S. ultra low-sulfur diesel futures (ULSD) , commonly known as heating oil, settled 2.94 cents higher at $3.1218 per gallon. It traded lower earlier in the session as traders sold contracts to exit positions ahead of Friday's expiration of the February contract.

The market awaited U.S. inventory data set for release by the American Petroleum Institute Tuesday at 4:30 p.m. EST (2130 GMT).

Analysts, on average, expect distillate stocks, including heating oil and diesel fuel, to fall by 2.2 million barrels, while U.S. crude stocks likely rose by 2.3 million, according to a Reuters poll.

The U.S. Energy Information Administration is expected to release its data on Wednesday at 10:30 a.m. EST (1530 GMT).

Meanwhile, global equities markets steadied after three days of intense selling, which also boosted oil prices.

Investors continued to watch the U.S. Federal Reserve as it considers further tapering of its bond-buying program. The central bank is expected to announce a $10 billion cut to its asset purchases in February at the conclusion of a two-day meeting on Wednesday.

A rollback would support the dollar, weighing on commodities priced in the currency. Investors have been concerned about the withdrawal of market-friendly U.S. monetary stimulus as well as unsettled conditions in emerging markets, which could pressure oil prices lower.

In the world's second-largest oil consumer, China's factory activity likely cooled in January to a six-month low, a Reuters poll showed, underscoring views that an economic slowdown there has continued into 2014.