LONDON Sterling fell late on Tuesday after surging on higher-than-expected inflation numbers and softer government rhetoric on Britain's planned departure from the European Union.
Focus was shifting to U.S. Federal Reserve and Bank of England policy statements over the next two days but traders said the pound would continue to struggle to break through resistance above $1.27 which has held for the past fortnight.
Consumer prices rose 1.2 percent last month year-on-year, the Office for National Statistics said, beating economists' expectation for a 1.1 percent annual rise in a Reuters poll.
That pushed sterling as high as $1.2723 in morning trade but a burst of mid-afternoon selling pushed it back to $1.2680 by 1600 GMT, still up marginally on the day. It dipped a quarter of a percent to 83.96 pence per euro.
"Inflation was clearly a little bit stronger than expected, and with the Bank of England meeting later this week, it will be interesting to see to what extent they are concerned," said Rabobank currency analyst Jane Foley, referring to the BoE monetary policy committee meeting scheduled for Thursday.
"But I think we will have to have a much more binding commitment to 'soft Brexit' to see sterling make that leap towards the $1.30 mark," she said, referring to market hopes that the UK will maintain close ties with the European Union even after it leaves the bloc.
Sterling fell sharply from its June highs of $1.5018 following Britain's vote on June 23 to leave the EU.
As a result, many economists expect prices to come under more pressure next year as the currency's weakness feeds through to the cost of imports. Yet market pricing suggests the Bank of England will look past that bounce as a one-off effect in aid of keeping interest rates low until the end of 2018 given the economic risks of the Brexit process.
"The market had to a large extent priced for higher inflation now - but the politics and (the manner of) Brexit is the overriding factor for sterling," Foley said.
The currency had also taken some support ahead of the data after comments from UK Chancellor Philip Hammond in favour of a staggered transition period for the country's exit from the EU.
Hammond backed the idea on Monday of a transition period to smooth the Brexit process and said EU countries also stood to gain from a gradual British withdrawal.
"Given this optimistic sentiment regarding a smooth divorce with the EU, we expect cable to continue trading higher for a while, at least ahead of the Bank of England policy meeting on Thursday," IronFX analyst Charalambos Pissouros said.
(Editing by Robin Pomeroy)