Crude oil prices have been rallying in recent weeks because the Federal Reserve is pursuing a policy of “quantitative easing,” a senior oil market analyst said last week.

Phil Flynn, a senior analyst and vice president for research at PFG Best in Chicago, told a commodity conference on July 21 that the current oil rally is not a function of demand and supply, just like last year’s rally that preceded the market crash in the fall had nothing to do with the fundamentals.

He said quantitative easing—a monetary policy used to stimulate an economy where interest rates are slashed drastically to near zero—was bullish in two respects. First off, it weakens the value of the U.S. dollar, making oil cheaper for buyers holding foreign currencies. In that sense, it artificially boosts demand.

Secondly, lower interest rates encourage borrowing, which leads to the so-called “green shoots” that appear to suggest the economy is recovering from recession. Again, that artificially boosts demand for oil.

But that artificial demand and the current rally just sets up the stage for another sharp drop in oil prices, which he predicts will happen later this year. He sees crude futures prices falling back to about $35 bbl by the year’s end, especially in light of Fed promises to adopt “an exit strategy” on the quantitative policy. He sees RBOB gasoline fall to $1.25 gal and No.2 oil falling to $1.50 by the end of 2009.

Fed Chairman Bernard Bernanke wrote in the Wall Street Journal on July 21 that the billions of dollars the Fed has pumped into the economy will not undercut its ability to push borrowing costs higher when the time is ripe.

At some point however, Bernanke said, the Fed “will need to tighten monetary policy to prevent the emergence of an inflation problem down the road.”

Flynn said once the Fed starts to tighten its monetary policy, oil demand will dry up irrespective of the expected economic growth.

That’s because the dollar will get stronger and attract all the investors currently using oil as a safer hedge against inflation.

In fact, Flynn said, oil prices rose last summer to a historic high of $147 bbl because investors were concerned about the fragile economy.

“Oil has been reflecting the fears, the uncertainties and hopes of investors about the financial crisis, so when the economy recovers and the crisis ends, oil will go down,” he added.