By Julien Ponthus
LONDON (Reuters) -Sterling held its ground against the dollar on Wednesday as traders assumed a rise in inflation in March would have little impact on monetary policy and waited for crucial activity and retail sales data due at the end of the week.
Consumer price inflation (CPI) rose to 0.7% in March after dipping to just 0.4% in February, as global oil prices rose and retailers scaled back their COVID-driven discounts.
The pound was down 0.05% at $1.3930 at 1450 GMT after experiencing some brief weakness during midday trading, but it remains in striking distance of the $1.40 mark it crossed on Monday for the first time in nearly a month.
Sterling rose about 0.1% against the euro at 0.8620 pence.
"CPI isn't a story that will be driving sterling in the short term", said Jeremy Stretch, a foreign exchange strategist at CIBC Financial markets.
Financial markets see about a 50% chance of a quarter-point increase in interest rates by the end of next year, but many economists think it might take the Bank of England longer to move.
In the short term, Stretch said, investors will focus on Friday's UK Composite Purchasing Managers' Index to gauge the strength of Britain's economic recovery.
Sterling has been among the best performing in the G10 group of currencies this year as investors hope Britain's rapid pace of vaccinations against COVID-19 will lead to a strong rebound from the country's worst economic contraction in 300 years.
Analysts at Rabobank wrote on Tuesday that the currency's rise may soon resume due to positive economic conditions.
"Now that many of the longs positions that were built in the pound during Q1 have been shaken out, it would appear that GBP bulls may be re-grouping", they wrote, adding that "support for the pound has come from anecdotal evidence highlighting an encouraging picture from freshly re-opened UK businesses".
Data on Tuesday added further signs that the economy is recovering, with Britain's unemployment rate unexpectedly falling for a second month in a row to 4.9% in the December-to-February period.
However, some investors remain cautious on the pound ahead of local elections on May 6, when a decisive victory for the Scottish National Party in voting for the devolved parliament in Edinburgh would increase pressure on the UK government to allow a second referendum on independence for Scotland.
Others stress that while Britain has been successful in rolling out its COVID-19 vaccination campaign, it might not yet be possible to get a sense of the economic cost of its decision to leave the European Union's single market.
It will take years rather than just a few months to make that assessment, said Francois Savary, CIO at Prime Partners.
"So for the time being I don't touch the pound," he said.
(Reporting by Julien Ponthus, editing by Larry King and Gareth Jones)