Gold drifts lower, tracks oil ahead of Fed

By Jan Harvey and Raissa Kasolowsky

LONDON (Reuters) - Gold drifted lower in Europe on Wednesday, tracking oil, but held within a range as the market waited for a key rate decision from the Federal Reserve and its statement to find more clues on future monetary policy.

Gold traded at $882.30/883.30 an ounce at 10:18 a.m. EDT from $888.70/889.70 an ounce late in New York on Tuesday.

Oil, a key external driver of gold, dropped to just below $136 a barrel ahead of U.S. government inventory data expected to show crude stocks fell for a sixth consecutive week.

"I think the drop in oil is the most likely scenario for the drop in gold but it is wedged in a pretty tight range," said analyst Michael Jansen, at JP Morgan.

"Positions are fairly small ahead of the rate decision."

The U.S. central bank is widely expected to leave interest rates unchanged at 2 percent. However, if it fails to adopt a widely expected hawkish tone in its statement, the dollar could suffer, buoying gold.

Gold moves in the opposite direction to the dollar, as it is often bought as an alternative investment to the U.S. currency. Dollar-priced gold also becomes cheaper for holders of other currencies as the greenback softens.

"If people are ruling out any early increases in interest rates, then you could see this as slightly negative for the dollar, which would be positive for gold," said Daniel Smith, an analyst at Standard Chartered.

"If they're flagging up much stronger increases then the opposite should take place."

The precious metal has benefited this week from a dip in prices, which are down around $30 from a month ago.

A $25 price slide on Monday was met by good buying from jewelers and institutional investors, with inflows into New York's largest ETF rising 2 percent that day.

"Jewelery demand, although low, is reported to pick up when prices fall to $880 an ounce, indicating a level of support," said Fairfax analyst John Meyer.

"No doubt if there was a sharp fall in the gold price then jewelers could start stocking up, since longer term expectations are of higher prices to come."

In supply news, an industry body said it expected Russian gold output to rise by 5.2 percent in the first five months of 2008 to 41.834 tonnes.

Russia is the world's fifth largest supplier of mined gold and its mine production has been falling for the last five years, but producers said this year may see a turning point in the trend.