UPDATE 1-Pound hugs $1.30 as impact of above-forecast inflation data fades

Sterling slipped back under $1.30 on Wednesday, shrugging off data showing an unexpected surge in UK inflation to a six-month high in January as focus returned to Britain's trade talks with the European Union and government plans to boost spending.

The data showed consumer prices rising at an annual rate of 1.8% compared with 1.3% in December, not far off the Bank of England's 2% target. A Reuters poll of economists had pointed to a rate of 1.6%. The pound firmed after the data to a session high of $1.3023, up 0.2% on the day, before slipping back to $1.2984 . Versus the euro, it rose from negative territory to trade flat, before easing back to 83.18 pence.

The figures confirmed money markets' view that rate cuts from the Bank of England in 2020 are unlikely any time soon; they currently see a 75% chance of a 25 basis-point cut by the end of the year, up from around 68% before the data. The appointment of Rishi Sunak as Britain's finance minister helped the pound last week to its best weekly performance in two months as expectations grew he would open the fiscal taps to boost an economy weakened by 3-1/2 years of Brexit uncertainty.

Sunak tweeted on Tuesday he expected to present the budget on March 11 as previously scheduled, pushing sterling higher, especially against the weak euro against which it scaled a two-month high. "There's the limited weakness in the pound but I would fade (sell into) rallies in euro-sterling for the time being," said Stephen Gallo, European head of FX strategy at BMO Capital, noting the stimulus probability as well as political stability following the December election.

He said the outlook for monetary easing was still uncertain, hinging on "the exact size of fiscal stimulus, the global backdrop and how quickly the UK can diversify its trade portfolio away from the eurozone". Melanie Baker, the senior economist at Royal London Asset Management, noted also that while headline inflation had jumped, domestically-driven inflation had stayed weak.

"Business sentiment and the follow-through to activity data will, however, be the more important determinant of whether the Bank of England cut rates or not in the coming months," she added. Investors now await advance readings of UK purchasing managers indexes (PMI) due on Friday.

Another sterling dampener is the 11-month post-Brexit transition period, during which Britain must set new trading terms with the European Union. Both sides have hardened their stance: the EU is demanding fair competition guarantees, Reuters reported on Tuesday, while British Prime Minister Boris Johnson's Brexit adviser said London would never be bound by the bloc's rules.

On Wednesday, an adviser to the EU's chief trade negotiator said talks would be tougher than the tortuous negotiations that secured the Brexit withdrawal settlement.