Nuri al-Maliki, the Iraqi prime minister, told a televised news conference on Thursday that al-Zarqawi had been "eliminated".

The plunge on Thursday deepened losses from a day ago, when US data showed rising crude and fuel inventories, easing concerns about summer supplies in the world's biggest consumer.

US crude oil fell $1.21 to $69.71 a barrel by 0818 GMT after losing $1.68 or 2% on Wednesday. London Brent crude fell $1.10 to $68.09 a barrel.

At the same time as oil prices fell, the US dollar rose, currency dealers said.

"Clearly, this news added to the momentum of the dollar, which was already on an upturn on the improved outlook for US interest rates," said Bank of Tokyo Mitsubishi UFJ forex analyst Masashi  Hashimoto.

"Whether this development will help revive sentiment towards the dollar from a long-term view point is still far from clear at this  point."

The US currency rose to as high as 114.03 yen and the euro fell to $1.2748 after news of the death broke, before the greenback pared its gains.

Shortly beforehand the dollar had stood at 113.85 yen, while the euro was at $1.2759.

Optimistic targets

Barham Salih, Iraq's deputy prime minister, said separately on Thursday that Iraq would produce 4.3 million barrels a day of crude oil by 2010, more than double its current levels, but analysts say those targets may be optimistic.

Baghdad is struggling to pump two million barrels a day, down from about 2.5 million before the US-led invasion in 2003.

Oil exports from Iraq have failed to return to pre-war levels due to frequent sabotage attacks on the country's northern pipeline and deteriorating security that has prevented significant investment in ageing southern oilfields.

Those curbs - coupled with the ongoing loss of a quarter of Nigeria's output and growing anxiety over Iran's supplies - have helped fuel a near 15% rise in oil prices since the start of the year, extending a rally that began after the US invasion of Iraq more than three years ago.