* Brent-US crude spread narrowest since early July
* US crude stocks rose last week, products fell-API
* Coming Up: EIA oil inventory data 4:30 p.m. EDT Tuesday (Adds API data)
By Robert Gibbons and David Sheppard
NEW YORK, March 26 (Reuters) - Brent crude rallied late on Tuesday to settle up more than $1 above $109 a barrel, after U.S. crude had surged to a five-week high above $96 a barrel, lifted by stronger manufacturing and housing data in the United States.
Brent's premium to U.S. crude CL-LCO1=R narrowed to as little as $12.52 a barrel at one point, the smallest in eight months. Brent's late rally moved the spread back to around $13 a barrel.
The spread has narrowed sharply from $23.45 in February. An improving U.S. economy and increased pipeline flows from the Midwest has supported the U.S. benchmark oil contract. Meanwhile, Brent's price has been pressured by increased supplies from the North Sea and concerns about Europe's economy, with Cypriot banks closed until Thursday.
Trading in Brent crude was choppy until the final hour of the session, when prices started to rally, eventually settling up $1.19 at $109.36 a barrel.
Brent has slid from above $119 a barrel in early February, but analysts and traders said market uncertainty may be abating.
U.S. crude settled up $1.53 at $96.34 a barrel, its highest closing price since Feb. 19.
"Brent had been limited by the concerns about Cyprus, but those seemed to give way to allow Brent to move up on the same supportive economic data from the United States," said Phil Flynn, analyst at Price Futures Group in Chicago.
Surging U.S. crude production over the past two years has widened Brent's premium, as stockpiles have swollen around the U.S. contract's land-locked delivery point in Cushing, Oklahoma.
But increased pipeline capacity is now starting to move more oil from the Midwest to coastal refineries. Producers are also shipping more crude to premium-priced markets via rail cars.
"The erosion (of the U.S. crude premium) is because U.S. shale production is decreasing imports of light sweet crude grades," said Seth Kleinman, head of energy research at Citigroup.
Kleinman said Brent-U.S. crude spread could narrow to $10 per barrel but was unlikely to shrink much further because of the increased cost of moving U.S. oil supplies while the inland infrastructure is still improving.
Data from industry group the American Petroleum Institute late on Tuesday showed U.S. crude oil stocks rose 3.7 million barrels last week, much higher than forecast in a Reuters survey of analysts. Inventories of gasoline and diesel also both fell more than expected.
The more closely-watched government data from the U.S. Energy Information Administration (EIA) is set for release at 10:30 a.m. EDT (1430 GMT) on Wednesday. (Additional reporting by Simon Falush in London and Jessica Jaganathan in Singapore; Editing by Bob Burgdorfer, David Gregorio and Marguerita Choy)