U.S. crude oil hit its highest level in 16 months on Thursday, rising above $108 a barrel on signs of a stronger U.S. economy and shrinking its discount to North Sea Brent to the narrowest in almost three years.

U.S. equity markets touched record highs as the Philadelphia Federal Reserve's closely watched survey of factory activity in the U.S. mid-Atlantic region hit a two-year high, boosting the outlook for demand in the world's largest oil consumer.

"The market is rallying on good economic news," said Phil Flynn, an analyst at Price Futures Group in Chicago.

"The Dow Jones is good, the Fed's Philly index is good, employment data is good, and WTI is reflecting that right now."

U.S. crude oil, commonly referred to as West Texas Intermediate or WTI, settled at a 16-month high of $108.04, up$1.56.

Brent crude oil rose 9 cents to settle at $108.70 a barrel, with its premium over U.S. crude touching an intraday low of just 51 cents a barrel, the narrowest spread since August 2010. The premium eventually settled at 89 cents.

The price difference between the world's two most heavily traded crude contracts has narrowed sharply in recent weeks as increased pipeline capacity has reduced the glut of oil around the WTI delivery point of Cushing, Oklahoma.

As recently as February the so-called Brent-WTI spread <CL-LCO1=R> had traded at more than $23 a barrel, but the U.S. benchmark has rallied by more than 25 percent in the last three months compared with just a 9 percent rise in Brent.

WTI got a further boost on Wednesday after data showed refiners in the United States last week had consumed more crude than at any time since August 2005, while stocks at Cushing fell by almost 900,000 barrels. Total U.S. crude stocks have fallen by around 27 million barrels in three weeks.

"I wouldn't be surprised to see WTI go over Brent," said Bob Yawger, director of energy futures for Mizuho Securities USA Inc in New York.

"It's been moving in that direction for a while, though it's hard to say whether it would stay that way for long. On the other hand, you have many refineries set up to receive sour crudes, so that's eventually bound to bolster Brent as the Gulf Coast refineries can only take on so much sweet crude."

U.S. oil futures also exhibited strong backwardation, with the spread between the September and October contracts widening to $1.56. Backwardation occurs when a front-month contract is stronger than the next one, and it is usually understood to indicate expectations for weaker demand in the following weeks.

"We are seeing a very steep backwardation in the September-October contracts - the last time it was that high was in 1990 after the start of the Iraq War," said Olivier Jakob, analyst at Petromatrix.

"So all the flows are going into WTI because of the backwardation," he added. The August WTI contract is to expire on Monday.

Analysts paid close attention to Federal Reserve Chairman Ben Bernanke's comments on Thursday when he testified before Congress for the second time in two days. Bernanke said recent unemployment and inflation levels suggest that the central bank needs to maintain a "highly accommodative monetary policy for the foreseeable future."

The market also watched geopolitical developments in the Middle East, as the African Union warned on Thursday that Egypt risks being engulfed in a civil war unless its newly installed interim government expands to include Islamists.