UPDATE 1-European stocks rally pauses ahead of Fed outcome

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March 22 (Reuters) - European stocks struggled for momentum on Wednesday after a tentative recovery in the past two sessions, with investors looking ahead to a crucial monetary policy decision from the Federal Reserve amid turmoil in the banking sector.

The pan-European STOXX 600 index inched up 0.1% after a two-day bounce, lifted by banking stocks following a series of measures to stabilise the sector in the wake of the collapse of three U.S. banks and trouble at lender Credit Suisse.

European banks index gained 0.7%, adding to a 5% jump in the past two sessions when UBS' state-backed takeover of Credit Suisse and coordinated actions by central banks to boost liquidity lifted sentiment.

The focus shifts to the Fed, which is expected to raise interest rates by 25 basis points (bps) later in the day, a decision that will land amid a brewing political storm over the U.S. central bank's oversight of recently collapsed Silicon Valley Bank.

The Fed decision is due at 1800 GMT and Chair Jerome Powell will speak at a news conference half an hour later.

"Markets are very much aware that the Fed is stuck between a rock and a hard place, with policymakers facing an apparent dilemma between financial stability or price stability," said Han Tan, chief market analyst at Exinity Group.

"If the dot plot points to a terminal rate that's higher than the 5.1% that FOMC officials forecast back in December, such hawkish clues may prompt another risk-off wave across the equity market."

Traders had priced in a 50 bps rate hike from the Fed earlier this month, but turbulence in the banking system and financial markets pushed them to drastically reduce their bets.

Money market traders are currently pricing in nearly 90% odds that the Fed will hike interest rates by 25 bps, according to CME Group's Fedwatch tool. They also see rates peaking at 4.95% by May.

UK's FTSE 100 lagged its European peers after a hotter-than-expected inflation reading raised the chances of another rate increase this week from the Bank of England.

Ubisoft climbed 1.8% after HSBC upgraded the French video game producer's stock to "buy" from "hold".

Marks and Spencer Group rose 3.6% after Citi upgraded the British retailer's stock to "buy", saying its savings plan will help margin recovery. (Reporting by Sruthi Shankar in Bengaluru; Editing by Sherry Jacob-Phillips and Sonia Cheema)