Sterling fell back from one-month highs against the dollar as speculation that a change in monetary policy could be on the cards faded after UK inflation data came in under forecast.
The pound fell back against the euro, down around 0.5% at €1.20 and also dipped from intra-day highs against the dollar.
The headline rate of inflation stood at 3.4%, marginally below market expectations, and curbed hopes of an early interest rate rise.
Duncan Higgins, senior analyst at Caxton FX, said: "There is now likely to be far less pressure to prematurely raise interest rates. Headline inflation still has some way to fall before meeting the 2% [Monetary Policy Committee] target, but it appears that factors applying upward pressure are now subsiding."
Mark Bolsom, head of the UK trading desk at Travelex Global Business Payments, added: "Doubtless the pound's better performance against the euro will have helped because we import heavily from Europe. It is too early to tell whether this is the start of a downward trend in inflation.
"On the other hand, it will concern investors that while inflation has eased, the Bank has done nothing to influence this. The Bank will not raise interest rates whilst Britain faces a period of extensive fiscal tightening and we remain vulnerable to a rise in inflation. If commodity prices rise, sterling drops back against the euro and food inflation rises, inflation will go up again."
This is looking increasingly likely after the emergency Budget when the coalition government is likely to announce severe cuts.
"Until then there will be uncertainty on the markets and EUR-GBP is likely to trend sideways. GBP-USD is therefore likely to be mainly driven by the moves in EUR-USD. Should the currency pair recover further, GBP-USD is also likely to benefit," according to analysts at Commerzbank.
Currency strategists say the euro's prospects are looking up slightly as the markets yesterday reacted in a calm manner to rating agency Moody´s decision to downgrade Greek bonds by four steps to junk status.
Commerzbank commented: "In the end Moody's was just lagging behind as all other rating agencies had already valued Greece as a non-investment grade. Just a few weeks ago the news would have created a euro selling wave. Now it was no longer newsworthy as the government in Athens immediately made it clear that the downgrade was not an evaluation of the country's consolidation efforts."
Speculation that Spain could apply for aid from the €500 billion Eurogroup aid fund as early as this weekend also met with a muted reaction.