The Metropolitan Police said it "has decided not to pursue, at this time, the application for production orders" against the paper.
The Guardian said Friday that police were seeking a court order that would force the paper to unveil source material for stories about the scandal.
The stories include a July 4 article that revealed the now-defunct News of the World tabloid hacked into the voicemail messages of missing British schoolgirl, Milly Dowler, who was later found murdered.
The Guardian had vowed to fight the demand, and rival newspapers joined it in condemning the police move to uncover reporters' sources.
Officials with the paper could not immediately be reached for comment Tuesday night.
The Guardian has been at the forefront of reporting the hacking scandal, exposing the Rupert Murdoch-owned tabloid for routinely intercepting the voicemails of those in the public eye in its quest for scoops.
A police officer has been arrested on suspicion of leaking information about the force's hacking investigation to the newspaper.
The force said it would consult prosecutors about the next steps in its investigation of the officer.
It said in a statement that "despite recent media reports there was no intention to target journalists or disregard journalists' obligations to protect their sources."
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