(Updates prices, adds quotes)
By Lucy Raitano
LONDON, May 18 (Reuters) - Britain's pound fell against the dollar on Wednesday, pulling away from almost two-week highs after data showing British inflation rising to a 40-year record raised concerns about a sharp economic slowdown given the pain inflicted on consumers.
At 1505 GMT, sterling was down 0.7% at $1.24225, having fallen as much as 1% in morning trading. It had also overnight, before the data, briefly touched its highest level in almost two weeks at around $1.25.
The drop reverses most of the gains made on Tuesday when strong labour market data had boosted expectations that the Bank of England would have to further increase interest rates.
But the latest inflation numbers fuelled fears that the threat of recession may temper how far the central bank can go, having delivered four rate hikes since December.
"Yesterday it looked like with wage growth rising and unemployment so low it meant that the bank had more room for manoeuvre," said Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.
"Now the eye wateringly high costs for consumers is going to lead to dropping consumer spending power which will have a deep impact on output in the UK economy."
Against the euro, the pound was down around 0.2% at 84.67 pence.
Consumer price inflation hit 9% in April, making Britain's inflation rate the highest of Europe's five biggest economies and almost certainly of the Group of Seven countries, with Canada and Japan yet to report figures for April. Neither are likely to match Britain's price growth.
“Of course the bank doesn’t want to be so aggressive that it pushes the UK into a deep downturn, but it knows it needs to pull some levers to try to keep a lid on inflation," said Streeter.
Soaring energy bills were the biggest inflation driver last month, and British households are now facing the biggest cost-of-living squeeze since records began in the 1950s.
"The market is repricing growth expectations in the UK and by extension reconsidering how far and doubting in a way whether the BOE will continue hiking at this pace," said Francesco Pesole, FX strategist at ING.
The outlook for aggressive rate hikes from the U.S. Federal Reserve has also made the dollar more attractive, further adding to the pound's weakness.
"Downside risks are unlikely to fade or evaporate in the coming months, and for the upside potential, especially with the Fed tightening and the U.S. economy doing very well, a move in cable close to the $1.30 level should prove pretty tough to sustain," said ING's Pesole.
Pesole said that concerns around the threat of a potential trade war between the European Union and Britain, following signals from the UK government on Tuesday of impending changes to parts of the Northern Ireland protocol, also suggested downside risks for sterling.
(Reporting by Lucy Raitano; Editing by Alison Williams)