UPDATE 2-Sterling hits two-week low after warning about Brexit transition deal

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LONDON, Feb 28 (Reuters) - Sterling skidded to a two-week low on Wednesday after the EU's chief Brexit negotiator said a transition deal was not guaranteed and Britain's prime minister said the EU's draft legal text would undermine the United Kingdom.

The British currency extended losses to trade down as low as 0.7 percent to $1.3808 versus the dollar, its weakest since Feb. 14.

Sterling has rallied this year, partly because investors are confident Britain can buy itself more time to agree terms of its departure from the European Union with a transition deal, that politicians want agreed in March at an EU leaders' summit.

But comments by EU chief negotiator Michel Barnier on Wednesday renewed concerns about whether that was feasible. Any delay could encourage doubt about an interest rate hike by the Bank of England in May, which investors now expect.

The BoE said this month that rates would need to rise a bit more than expected and sooner as the economy showed resilience and inflationary pressure grew. But its monetary assessment is dependent on the smooth progress in talks with the EU.

"Barnier's comments indicate negotiations could be complicated and drawn out and sterling is reacting to that, but we would be buyers of sterling if it falls quite substantially," said Morten Helt, a strategist at Danske Bank in Copenhagen.

Barnier said talks on a post-Brexit transition period had confirmed "significant divergences" and said Britain must "pick up the pace" of talks if it wants a deal this year.

Against the euro, sterling hit the day's lows, trading down 0.6 percent at 88.450 pence. But it was still within a broad 87-89 pence per euro band that has held in recent weeks.

Barnier urged London to "pick up the pace" of talks if it wanted a deal this year on a draft treaty.

A draft legal text published by the European Commission drew criticism from a unionist party in Northern Ireland and British Prime Minister Theresa May said it would undermine the UK's common market and threaten its constitutional integrity.

As more negative Brexit-related headlines have emerged, investors have whittled down long positions in sterling.

"The ongoing Brexit uncertainty continues to undermine the pound. Sterling would otherwise be a lot higher given that the Bank of England has recently turned hawkish amid the recent improvement in UK data and rising levels of inflation," said Fawad Razaqzada at Forex.com.

Latest positioning data by Commodity Futures Trading Commission on Friday showed that long sterling positions fell to $8.2 billion compared to nearly $33 billion in late January. (Reporting by Saikat Chatterjee Editing by Matthew Mpoke Bigg and Edmund Blair)