* Oil jumps to 3-1/2-year high on global supply fears
* World stocks rally, lifted by the energy sector
* Dollar hits 2018 high before edging lower
By Herbert Lash
NEW YORK, May 9 (Reuters) - Crude oil prices rose to 3-1/2-year highs on Wednesday following President Donald Trump's decision to withdraw the United States from a nuclear deal with Iran, a move that helped lift equity markets as Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and other oil majors rallied.
Contracts for Brent, the global crude benchmark, and its U.S. counterpart climbed more than 3 percent to highs last seen in November 2014 after Trump on Tuesday abandoned the deal and announced the "highest level" of sanctions against Iran.
Trump's action raises the risk of conflict in the Middle East and casts uncertainty over oil supplies in an already tight market. crude CLcv1 rose $2.08 to settle at $71.14 per barrel and Brent LCOcv1 settled up $2.36 at $77.21.
The energy sector in equity markets rallied, helping lift European stocks, a gauge of world equity performance and the broad U.S. market.
"It's the clear leader today. It's overwhelming almost all the other sectors in terms of its impact on today's market action," said Michael Arone, chief investment strategist at State Street Global Advisors in Boston.
Exxon Mobil XOM.N rose 2.27 percent, Chevron CVX.N gained 1.87 percent, Royal Dutch Shell (LON:RDSa) RDSb.L closed up 3.38 percent and BP BP.L ended 3.92 percent higher.
While crude oil prices have rallied over the past 12 months, energy stocks have basically gone nowhere, which helped their gains on Wednesday, Arone said.
"Now we're starting to see that gap close, so this could be a bit of a short-term rally for the energy sector," he said.
MSCI's gauge of equity performance in 47 countries .MIWD00000PUS rose 0.6 percent. Exxon and BP were the second- and third-largest contributors earlier in the session. Technology stars Alphabet GOOGL.O and Facebook FB.O later led stocks higher.
Energy added the most points to the pan-European FTSEurofirst 300 index .FTEU3 of regional stocks, which closed up 0.74 percent, led by Royal Dutch Shell and BP. Total TOTF.PA was the fifth-largest gainer.
On Wall Street technology led stocks higher, but the S&P energy sector .SPNY was the biggest percentage gainer at 2.25 percent.
The Dow Jones Industrial Average .DJI rose 174.23 points, or 0.72 percent, to 24,534.44. The S&P 500 .SPX gained 26.98 points, or 1.01 percent, to 2,698.9 and the Nasdaq Composite .IXIC added 72.83 points, or 1 percent, to 7,339.74.
Equities have recently traded in a range on concerns about U.S.-China trade negotiations, differing views by the Federal Reserve and investors over inflation and the economy, and the notion that earnings and growth have peaked, Arone said.
"Those things certainly have the market in a bit of a sideways pattern," he said.
The dollar fell from its strongest levels in 2018 against a basket of currencies because of mild profit-taking, but the greenback was expected to resume its rise as a result of solid U.S. economic growth and further monetary tightening by the Fed.
A bounce in the euro, which dropped to a low for the year in early trading, helped weaken the dollar.
"There's a little exhaustion with the long-dollar trade, but I don't think we've reached the end of it yet," said Ilya Gofshteyn, FX and global macro strategist at Standard Chartered (LON:STAN) Bank in New York.
The dollar index .DXY fell 0.08 percent, with the euro EUR= down 0.02 percent to $1.1860. The Japanese yen JPY= weakened 0.51 percent versus the greenback to 109.67 per dollar.
Benchmark 10-year notes US10YT=RR fell 9/32 in price, pushing their yield up to 3.0042 percent.
In Europe, the gap between Italian and German borrowing costs hit its widest in nearly six weeks on the possibility a coalition of Italian anti-establishment parties could come to power.
The Italy/Germany 10-year government bond yield spread widened five basis points immediately after news that 5-Star and the League had said they were holding last-minute talks to try to clinch a coalition deal.
The spread widened to 132.7 basis points, its most since March 29. IT10YT=RR DE10YT=RR
Gold prices slid as safe-haven buying failed to kick in after the U.S. withdrawal from the Iran nuclear accord.
U.S. gold futures GCcv1 for June delivery settled down 70 cents at $1,313 per ounce.
"The fact that the cat is out of the bag and we have the announcement (on Iran) - that has removed some of the geopolitical support for gold," said Ole Hansen, head of commodity strategy at Saxo Bank in Copenhagen.