UPDATE 5-Oil extends gains, on track for biggest weekly rise this year

* Brent, WTI futures at 8-week highs

* Brent front curve flips into backwardation

* WTI-Brent spread widest in 2 months

* Shell extends Force Majeure of Nigeria's Bonny Light oil (Adds spread move, milestones, comments; changes dateline to NEW YORK, previous LONDON)

NEW YORK, July 28 (Reuters) - Oil prices edged up on Friday, reaching two-month highs and on track to post the strongest weekly percentage gains this year amid short covering and as investors digested signs of easing oversupply.

U.S. crude and gasoline inventories fell much more steeply than expected this week and the world's biggest oil exporter Saudi Arabia said it would further reduce oil output in August.

Brent crude futures were up 86 cents at $52.35 a barrel at 11:35 a.m. EDT (1535 GMT) after reaching a two-month high of $52.68 a barrel. The front of the crude oil curve <LCOc1-LCOc2> jumped into backwardation however, with the month-ahead trading above the subsequent month, showing investors are not expecting recent gains to last.

Short covering in the September contract contributed to the rally in the front-month spread, traders said. Physical markets have firmed due in large part to very strong refining margins.

Royal Dutch Shell Plc extended its force majeure on exports of Nigeria's Bonny Light crude oil to cover the outage of the Trans Niger pipeline, a statement from the company said on Friday, providing further support to Brent crude.

U.S. West Texas Intermediate (WTI) crude futures were up 57 cents at $49.61 a barrel, after also touching a two-month peak of $49.78 a barrel. Both Brent and WTI contracts are set to post their biggest weekly percentage gains this year with a rise of more than 8 percent.

"Both markets are seeing a strong move in spreads through most of 2017 and 2018 due to shorts covering into heavy producer flow," said Scott Shelton, broker at ICAP in Durham, North Carolina.

"Overall, I think the bullish demand story is taking the headlines away from the supply story as products are strong globally when refinery runs are maxed and that implies that current demand expectations could be significantly below reality."

The gains in Brent pushed the difference between the two benchmarks <WTCLc1-LCOc1> to the widest in two months.

"We also see tightness in August RBOB gasoline going into Monday's contract expiration, with futures traders apparently caught short by the inventory data for last week," Tim Evans, Citi Futures' energy futures specialist, said in a note.

U.S. gasoline futures for delivery in August were up more than 1 percent at the highest since May 24.

U.S. crude stocks fell sharply by 7.2 million barrels in the week to July 21 due to strong refining activity and an increase in exports, according to data from the Energy Information Administration (EIA). Gasoline stocks fell by 1 million barrels, compared with analyst expectations for a 614,000-barrel drop.

Brimming U.S. crude supplies have challenged production cuts to prop up prices led by the Organization of the Petroleum Exporting Countries, meaning weekly U.S. inventory data is closely watched.

However, some analysts' assessments of the oil market remained bearish.

"We believe the latest price rise is on a fragile footing," analysts at Commerzbank said, adding OPEC production was likely to rise in the coming months as the group has not officially capped output from members Libya and Nigeria.

Investors were eyeing an update on the U.S. rig count expected later on Friday to assess any signs of a slowing down in drilling activity.

(Additional reporting by Karolin Schaps in London, Jane Chung in Seoul; Editing by Adrian Croft and Chris Reese)