Sterling slipped from a one-year high against the dollar set earlier on Wednesday and edged down versus the euro after the Bank of England said its growth profile was slightly weaker than the previous projection.
The BoE, in its quarterly report, also said it saw inflation rising in the near term and then falling back to its 2.0 percent target in two years, assuming interest rates rise very gradually as implied by the market yield curve.
"The inflation report failed to validate the degree of hawkishness priced in short sterling markets. Short sterling futures are aggressively pricing in rate hikes," said Steven Pearson, chief currency strategist at HBOS Treasury Services.
By 1415 GMT, the pound was down 0.1 percent at $1.8645, after rising to $1.8734 earlier, its highest since May 2005.
Against the euro it was down a third of a percent at 68.51 pence, having risen to a two-month high of 68.26 on Tuesday. The central bank also said it saw the sterling exchange rate index falling to 97.8 by the second quarter of 2008. On Wednesday, it hit an eight-month high of 101.00, before falling back.
Domestic data have been upbeat over the past few weeks, quashing expectations of a British rate cut and prompting speculation that the next move may even be a hike from 4.5 percent.