* President Correa says 'unfortunate incident' over
* WikiLeaks founder Assange still trapped in building
By Girish Gupta and Eduardo Garcia
QUITO, Aug 25 (Reuters) - Britain has withdrawn a threat to enter Ecuador's embassy in London to arrest WikiLeaks founder Julian Assange who has taken refuge there, President Rafael Correa said on Saturday, taking the heat out of the diplomatic standoff.
"We consider this unfortunate incident over, after a grave diplomatic error by the British in which they said they would enter our embassy," Correa said in a weekly media address.
In a statement, Ecuador's government said it had received "a communication from the British Foreign Office which said that there was no threat to enter the embassy."
Ecuador was furious after the British government warned it might try to seize Assange, who has been holed up in the building for more than two months trying to avoid extradition to Sweden, where he is wanted for questioning over rape and sexual assault allegations.
Ecuador, which has granted the former computer hacker asylum, demanded that Britain's threat be retracted. The latest move should improve relations between Quito and London and allow more talks on Assange's fate to take place.
For now, however, Assange remains trapped in the embassy with British police waiting outside. Britain has said it is determined to fulfill a legal obligation to send him to Sweden.
The Washington-based Organization of American States had condemned Britain's threat, and South American foreign ministers strongly backed Correa's position that Britain's warning was unacceptable and could set a dangerous precedent.
Correa says he shares Assange's fears that if handed over to Sweden, he could then be extradited to the United States to face charges over WikiLeaks' 2010 publication of secret U.S. cables.
U.S. and European government sources say the United States has issued no criminal charges against the WikiLeaks founder and has launched no attempt to extradite him.
Ecuador's government says it never intended to prevent Assange from facing justice in Sweden. It has said that if he received written guarantees from Britain and Sweden that he would not be extradited to any third country then Assange would hand himself over to the Swedish authorities.
Assange, whose platinum hair and friendships with the rich and famous have helped make him a global celebrity, spoke from the embassy's balcony last weekend, denouncing what he called a "witch hunt" by the United States against him and WikiLeaks.
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