*

BoE holds rates but policy split widens

*

February rate cut now looks more likely - analysts

*

Short-dated gilts win reprieve from dovish tone

(Updates throughout)

By Harry Robertson and Naomi Rovnick

LONDON, Dec 19 (Reuters) - A dovish message from the

Bank of England on Thursday dented the outlook for sterling, one

of the year's best performing major currencies against the

dollar, while bringing a reprieve to Britain's battered

government bond markets.

The pound slipped and two-year gilt yields pulled back from

seven-month peaks after the BoE held its key interest rate at

4.75%, as expected, but three policymakers voted to lower

borrowing costs.

Analysts said the surprise vote split highlighted the risks

of British interest rates falling faster than anticipated next

year - a development that could weigh on sterling but shore up

bond markets.

Data this week showed growth in British wages sped up in the

three months to October and inflation rose to an eight-month

high of 2.6% in November, seemingly cementing the case for the

BoE to lower rates only gradually next year.

Yet growth has stalled. Britain's economy shrank for a

second month in a row in October.

"The Bank of England will follow the ECB in 2025. They can

easily afford to lower rates progressively," said Florian Ielpo,

head of macro at Lombard Odier in Geneva, referring to the

European Central Bank.

"We're in dire need of a recalibration of monetary policy

because policy globally, the level of risk-aversion, is more

consistent with the inflation we had two years ago than the

inflation we have at the moment."

The pound was last up 0.3% at $1.2611, having risen

as much as 0.7% earlier in the day, as it recovered from a sharp

drop in the previous session when a hawkish tone from the U.S.

Federal Reserve sent the dollar surging.

It has fallen around 0.9% against the dollar since January

but remains one of the strongest major currencies this year.

The euro was up around 0.2% at 82.48 pence - pulling back

from around its lowest levels against sterling since March 2022,

which is within striking distance of levels seen in June 2016.

BOND REPRIEVE?

Signs of a shift among British rate setters went down well

with bond investors, who have pushed up gilt yields this year

given sticky inflation and high debt. When bond yields rise,

their price falls.

Britain's 10-year gilt yield has surged 100 basis points

this year , underperforming U.S. and German peers.

It was last trading 2 bps higher on the day at 4.583%, in

line with U.S. Treasuries. Rate-sensitive two-year bond yields

fell more sharply and were last 1 bp lower.

"The UK needs some stimulus and the way the bank votes split

today suggested that we could see maybe three cuts next year

instead of two," said Neil Birrell, CIO at Premier Miton

Investors.

"I'm genuinely struggling to see where the growth is coming

from."

Traders price in roughly 55 basis points worth of British

rate cuts next year, compared with around 45 bps just before the

decision.

"We're overall positive on fixed income as yields at the

moment are quite attractive," said Ielpo, adding this included

gilts.

The BoE contrasted with the Fed, which on Wednesday cut

rates but said it envisaged just two reductions next year

instead of the previous four, sending the dollar surging and the

pound down more than 1%.

Britain's FTSE 100 was last down 1.1%, trimming

earlier falls. Mid-sized companies on the FSTE 250 index

also perked up somewhat, with the gauge last down 1%.

Birrel said he maintained a positive bias on British stocks.