The Liverpool winger is suspended for England's final warm-up game against Honduras on Saturday after he was sent off for a reckless challenge on Ecuador's Antonio Valencia.
Hodgson warned Sterling that he may have blown his chance of starting against Italy in Manaus on June 14 after seeing red in Wednesday's 2-2 draw.
However, Sterling has since responded positively in training and Hodgson now appears to have had a change of heart.
"His reaction has been excellent," Hodgson said.
"You the saw the games and the passing practice we did today and I thought he was unstoppable at times. Some of the things he did out there were quite breathtaking.
"I'm disappointed he won't play (against Honduras). I was going to start him, but it doesn't affect his chance of playing in the first team when the tournament starts.
"He's still making me aware he's a player who can inflict an awful lot of damage on the opposition. He is an exceptional talent, along with our other exceptional talents."
If anyone can take credit for the way Sterling has responded then it is his captain and Liverpool team-mate Steven Gerrard.
Gerrard escorted Sterling off the pitch following his dismissal against Ecuador and told the 19-year-old he must not take the red card to heart.
His words seem to have had an effect and Gerrard said: "He's very resilient. He was the best player in training this morning.
"Straight away after the incident I spoke to him in the dressing room and I said it was important he put himself back in the frame for Italy, and he's done that."
Sterling went over the top of the ball and took out Valencia in the dying minutes of the 2-2 draw, and the Manchester United midfielder reacted by grabbing the Liverpool player by the neck.
Both were sent off and Jack Wilshere was lucky not to join them in the dressing rooms for striking out at Valencia in the melee that unfolded.
Hodgson has reminded his players there must be no such carry-ons in Brazil.
"We talked about (the incident) to be honest," he said.
"I don't think it was an ill-disciplined act. It was an over exuberant, slightly reckless act."