Britain's FTSE sails on sterling slide after BoE

* FTSE 100 up 0.5 pct at close

* BoE (Shenzhen: 000725.SZ - news) keeps rates on hold, pound falls

* RBS (LSE: RBS.L - news) up on smaller-than-expected U.S. settlement

* BT drops after disappointing update, job cuts (Recasts, adds quote, detail and graphic; updates prices at close)

By Danilo Masoni and Kit Rees

MILAN, May 10 (Reuters) - The UK's top share index hit a fresh 3-1/2 month high on Thursday after a decision by the Bank of England to keep rates on hold pushed sterling lower, while shares in Royal Bank of Scotland surged after it settled a probe in the United States.

The FTSE index closed 0.5 percent higher at 7,700.97 points, outperforming a slightly negative European market.

Sterling dropped after the Bank of England held interest rates steady as expected, but trimmed some losses after Governor Mark Carney told the BBC that he expected a rate rise over the course of the next year if there are no shocks to the economy.

"In light of the current uncertainty, the Bank is, understandably, inclined towards a more hesitant rather than pre-emptive approach to normalising policy," Karen Ward, chief market strategist for the UK and Europe at J.P. Morgan Asset Management, said, referring to uncertainty around Brexit.

Weakness in the pound against a surging dollar has been supporting the FTSE recently, helping the internationally-exposed index recover from losses suffered at the start of the year.

Away from economics, the FTSE was boosted by a 3.8 percent move higher in RBS' shares after it agreed to pay a smaller-than-expected $4.9 billion to resolve a U.S. investigation into its sale of mortgage-backed securities.

Analysts, who had estimated the U.S. could impose a fine of up to $12 billion, said the bank could reinstate a dividend.

"It’s a happy day for RBS, with the DoJ settlement coming in well below what we had feared," said Neil Wilson, Chief Market Analyst at Markets.com.

"The settlement also paves the way for a quick return to annual profits after ten years of losses and dividends will once again start flowing," Wilson (Oslo: WILS.OL - news) added.

Next (Frankfurt: 779551 - news) 's shares were the biggest risers, up more than 6 percent after a strong outlook and trading update, while ITV jumped after saying that advertising growth was in-line in the first quarter.

BT, however, fell 7.4 percent.

Traders said its latest update showed a disappointing guidance, while Jefferies analysts highlighted that the company missed on the opportunity of announcing a bolder mover of fiber roll out while the 13,000 job cuts were bigger then expected.

Randgold was another weak spot, down 7 percent after its quarterly profit fell, while

Among mid-caps, Superdry plummeted more than 19 percent after the fashion retailer said it expected 2018 full-year gross margins to decline and it gave a weaker than expected revenue forecast for 2019.

(Reporting by Danilo Masoni and Kit Rees; Editing by Toby Chopra)