UPDATE 2-Sterling briefly falls after BoE cuts growth forecast

Sterling briefly fell more than half a percent on Thursday before recovering its losses and rising toward $1.30 in volatile trade after the Bank of England said Britain faced its weakest economic growth in a decade due to Brexit uncertainty.

The speed at which the British currency retraced its losses reflected how investors are focused more on ongoing Brexit talks than on the central bank's economic outlook. At a time when other major central banks have said they will hold off from raising borrowing costs, the BoE stuck to its message that interest rates will rise if an EU divorce deal is done.

"The BoE was pretty balanced and pointed to robustness in the labour market ... the message was that, when Brexit is resolved, the economy will be lifted and that caught some people off guard ..." said Nomura strategist Jordan Rochester. The pound, which was trading down 0.3 percent before the rate decision, dropped as low as 0.6 percent on the day to $1.2854, a two-week low.

But it quickly recouped all those losses to trade up 0.3 percent against the dollar at $1.2978. Against the euro, it strengthened half a percent to 87.28 pence. "Sterling markets are broadly pricing in the short-term Brexit uncertainty," said Viraj Patel, a currency strategist at Arkera, a financial technology firm. "All eyes are on Westminster and Brussels."

While other central banks have said they will hold off from raising borrowing costs, the Bank of England restated that gradual and limited rate rises lie ahead for Britain, as along as a no-deal Brexit in just 50 days' time is averted. Money markets were pricing in about 41 percent probability of another quarter point rate hike before the end of the year compared to a 50 percent probability before the rate decision.

"Assuming an amicable outcome to the Brexit negotiations, there are enough hawkish signals in the inflation report to conclude that the BoE could hike rates later this year, which should support the currency," Dean Turner, UK economist at UBS Wealth Management said. The pound was especially volatile after the rate decision, briefly falling below a 100-day moving average of $1.2896 before bouncing off an intraday low of $1.2854.

Two-week to one-month risk reversals on the pound, a ratio of calls to puts on sterling, showed an increased bias towards selling as Britain's scheduled March 29 exit from the European Union nears. Prime Minister Theresa May will call on the European Union on Thursday to work with her to change the Brexit divorce deal and help her win the support of a divided parliament to smooth Britain's departure from the bloc.

On Wednesday, European Council President Donald Tusk had said the EU would make no new offer on Brexit, and those who had promoted Britain's exit without any plan of how to deliver it deserved a "special place in hell". (Reporting by Saikat Chatterjee; Editing by Toby Chopra and Kevin Liffey)