Sterling retreated on Thursday as inflation data in the UK is higher than any other country in Western Europe and proving more persistent than forecast.
In March, the UK's headline inflation declined to 10.1% from February's 10.4% but remained far above expectations for a decline to 9.8%, according to data published on Wednesday.
In addition, the Office for National Statistics report revealed price pressures are rife, and not just because of the steep rise in energy costs over the last couple of years, Reuters reports.
At the time of writing, the Sterling was flat against the greenback at $1.244 and edged down 0.1% against the Euro at 88.19 pence.
So far this year, the Pound is the second-best performing G10 currency against the Dollar, gaining 2.67%, just trailing the Swiss Franc, which registered a 3% gain during that time.
The likelihood of the Bank of England having to increase rates more than forecast has, in part, driven flows into the Pound. That said, the boost may not last due to the effect of high prices on businesses and households.
"The type of inflation the UK has now — linked to an energy crisis, labour shortages, and a term of trade shock — is never good for a currency. It's an erosion of internal purchasing power. Simply look at real wage growth," said Stephen Gallo, global currency strategist at BMO Capital Markets.
Real wages in the UK, earnings adjusted for inflation, revealed one of the largest record declines in the three months to February, with a 4.1% drop year-on-year.
According to money markets, traders are of the opinion the Bank of England will hike rates to around a 5% peak by this November from the current 4.25%. Last month, the forecast was for a 4.00% peak.
"You probably don't want to be buying Sterling if core inflation remains stubborn above 5% after three more 25 bps rate hikes from the BoE, which is currently priced into (overnight index swaps)," Gallo stated.
"Flipside, if the Q2 data reveal a meaningful drop in price pressures, there is probably a stronger case for Sterling to avoid an isolated decline. My base case is the second scenario, but I am more worried about the first," he added.