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* Graphic: Sterling and gilt yields bit.ly/2dgAXn1
* Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh
* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv (Updates story)
By Ritvik Carvalho
LONDON, Feb 27 (Reuters) - Sterling hit a 12-day low against the dollar on Monday, as talk of another possible Scottish independence vote added to fears about Britain's future as it prepares to leave the European Union.
A report in the Times newspaper said British Prime Minister Theresa May is preparing for Scotland to call a fresh independence referendum in March, to coincide with the triggering of Article 50 -- Britain's formal notification to leave the EU.
Traders said that had weighed on the pound, which skidded by as much as 0.7 percent to $1.2384 in early European trade - its lowest in nearly a fortnight - but had recovered some of those losses by 1350 GMT, last trading down 0.4 percent at $1.2414.
A separate report in the Telegraph newspaper reported that May is planning to curb freedom of movement for EU citizens as soon as she triggers Article 50.
A spokesperson for the prime minister said the threat of a fresh Scottish independence vote was creating unnecessary uncertainty and division, and that the prime minister has not yet set a timetable for her migration policies, which gave the pound some relief.
"While (a second Scottish referendum is) a tail risk at this stage ... such risks are yet to be adequately priced into the currency," ING FX strategist Viraj Patel wrote in a note to clients.
Against the euro, sterling fell 0.7 percent to a one-week low of 85.35 pence per euro.
Analysts also pointed to the likelihood that a merger to create Europe's biggest stock exchange would be scuppered as a reason for sterling's weakness on the day.
"The merger between LSE and Deutsche Boerse may be off the table and I think that's flagged sentiment," said Richard Cochinos, European head of G10 currency strategy at Citi.
Sterling has lost nearly a fifth of its value since Britain voted to leave the European Union in a referendum last June, with data providing a mixed picture of the British economy.
A survey on Monday showed optimism among businesses in Britain's services sector is now higher than at any time since June's vote to leave the European Union, despite the prospect of rising costs and prices eroding profits.
Associated British Foods, owner of discount fashion retailer Primark, said it was not seeing any signs that British consumers were starting to rein in spending, contradicting official data which has pointed to a slowdown.
"On top of soft data from the UK recently ... these fresh signals of a 'hard Brexit' and the risk of another Scottish referendum, enhances our view that the broader outlook for sterling remains negative," analysts from retail broker IronFX said in a note to clients.
"Our favorite proxy for any potential sterling softness in the foreseeable future is still sterling/yen, considering that the looming political risks in Eurozone could strengthen the yen due to its safe haven status." (Editing by Catherine Evans and Richard Lough)