The pound declined on Tuesday (14 February), after data showed the rate of inflation in Britain fell short of expectations, despite hitting the highest level in over two-and-a-half years.

Having climbed above €1.18 earlier in the session, sterling fell after the inflation report and, by early afternoon, it was trading 0.52% and 0.34% lower against the euro and the dollar, trading at €1.1752 and $1.2484 respectively.

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"The pound weakened as investors took the view the Bank of England's Monetary Policy Committee will continue to take an unhurried approach to raising headline interest rates from their current record low of 0.25%," said Russ Mould, investment director at AJ Bell.

According to the Office for National Statistics, inflation rose 1.8% year-on-year in January, up from the 1.6% reading recorded in December and higher than the 1.9% figure analysts forecast.

The reading meant inflation as measured by the consumer price index has reached its highest level since June 2014, although it remained short of the BoE's 2% target.

However, Ian Stewart, chief economist at Deloitte, said the pound was not the only factor behind the increase in inflation.

"Rising inflation is not just a UK phenomenon and is not just currency-related," he said.

"Prices are rising across the West, as higher fuel and other commodity prices feed through to consumers. In fact, German prices have risen faster than UK prices in the last year and last month Germany's inflation rate was higher than the UK's."

Elsewhere, the euro gained ground against the dollar, rising 0.25% against the greenback to $1.0624, despite some negative economic data showing the Eurozone economy grew 0.4% in January, rather than 0.5% as originally estimated.

The revision came after both Italy and Germany recorded weaker-than-expected growth, as the respective economies expanded 0.2% and 0.4% in the final three months of 2016.

Across the Atlantic, meanwhile, the dollar was firmly on the back foot, relinquishing the previous session's gains as investors awaited Federal Reserve chair Janet Yellen's testimony in front of the US Congress later today.

The dollar fell 0.27% against the yen to ¥113.43, declining 0.31% and 0.62% against its Canadian and Australian counterparts, to trade at CAD$1.3030 and AUD$1.3004 respectively.

"The sideway price action in the dollar for the past three trading days suggests two things, either markets believe that Yellen won't reveal any new hints, or they're waiting for a sign to react upon," said FXTM chief market strategist Hussein Sayed.

"If she does indicate that the Fed is ready to act as soon as March, we may see a decent rally in US yields that is going to support the dollar and probably limit any potential gains in equities."

Yellen will speak at 3pm GMT, followed by an appearance before the House Financial Services panel on Wednesday. Shilen Shah, bond strategist at Investec Wealth & Investment, said her stance was complicated by the uncertainty that has surrounded the US's fiscal policies since Donald Trump's appointment.

"Despite the large degree of uncertainty over the path of US fiscal policy, the Fed continues to project a path of stability with the market currently only projecting a gradual interest rate cycle," he said.

"The uncertainty over fiscal policy however does mean that the Fed is flying blind over the amount of fiscal stimulus the federal government is likely to provide to the economy over the next 12-18 months."