You can work around it by telling where to look for the ISO. A while ago I used this to boot a Debian live system:

  menuentry "Debian Sid LXDE Live" {
  insmod ext2
       loopback loop /isos/debian-sid-lxde.iso
       linux (loop)/live/vmlinuz-3.14-1-amd64 initrd=/live/initrd.img-3.14-1-amd64 quiet boot=live config fromiso=/dev/sda1/isos/debian-sid-lxde.iso toram=filesystem.squashfs noeject quickreboot hostname=debian username=liveuser locales=de_DE.UTF-8 keyboard-layouts=de nopersistence
       initrd (loop)/live/initrd.img-3.14-1-amd64
  }