Sterling edges back towards 10-month high against dollar

* Graphic: sterling and gilt yields http://bit.ly/2dgAXn1

* Graphic: World FX rates in 2017 http://tmsnrt.rs/2egbfVh

* Graphic: Trade-weighted sterling since Brexit vote http://tmsnrt.rs/2hwV9Hv

LONDON, July 28 (Reuters) - The pound climbed back towards its highest levels in 10 months against the dollar on Friday, boosted by hopes that Britain will exit the European Union under a transitional deal, and as the greenback fell broadly.

Finance minister Philip Hammond said on Friday he wanted to avoid a "cliff-edge" scenario under which goods and people would stop being able to move across Britain's borders when it left the EU in March 2019.

Hammond said EU nationals would continue to be able to work in Britain immediately after its exit from the EU, and changes to rules affecting relations with the bloc could be phased in gradually over the transition period, which should be completed by 2022, when Britain holds its next scheduled parliamentary election.

Separately, the Financial Times reported Hammond as telling business leaders he wanted companies to have full access to the single market and customs union for two years after Brexit, followed by a further implementation phase.

Hammond's comments followed similar ones from fellow cabinet ministers in recent weeks, which have led investors to bet on a lower chance of a "hard Brexit" in which Britain would lose preferential access to the single market, giving some support to the UK currency.

Sterling was up 0.4 percent at $1.3125 by 1600 GMT, close to the high of $1.3159 touched the previous day, having been boosted in the afternoon against a dollar weakened by weak U.S. GDP data.

"A transitional deal could increase the likelihood of a smoother Brexit, which we think over time could supportive of a stronger pound," said MUFG currency economist Lee Hardman, who expects sterling to have recovered to around $1.40 by the second quarter of next year.

"But at this point, given the potential pitfalls along the way, the market isnt willing to buy into that scenario."

ING currency strategist Viraj Patel said the EU would have to agree to such a deal before traders begin to price it in, and for the currency to rally further.

"Its good that the UK is moving towards this centre ground on Brexit, but equally we need to see what the EU are willing to offer," Patel said. "For markets to really start pricing this in, we need some consensus there."

The European Commission said on Friday that discussions about a potential Brexit transition period could only begin one divorce issues were settled.

Against the euro, sterling has lost almost 15 percent since the Brexit vote. It was down 0.1 percent on the day on Friday at 89.46 pence.

Investors are now looking ahead to next Thursday, when the Bank of England will make a policy decision and release its quarterly Inflation Report.

For a Reuters graphic on views of the Monetary Policy Committee's members, please click on: http://tmsnrt.rs/2eSYykb

Most analysts and economists expect the bank to keep interest rates at their record lows for now, although Nomura is calling for a hike.

"With measures of uncertainty having eased, interest rates low, balance sheets encouraging, corporate profitability rising, low sterling enticing inward investment and a resilient global recovery, investment looks set to rise, not fall," the bank wrote on Thursday, among "20 reasons to justify higher rates". (Reporting by Jemima Kelly; editing by John Stonestreet)