Effects of poly(ethylene glycol) (PEG) conjugation on peptide interactions with lipid membranes and lipopolysaccharide (LPS) were investigated for KYE28 (KYEITTIHNLFRKLTHRLFRRNFGYTLR), an antimicrobial and anti-inflammatory peptide derived from human heparin cofactor II. In particular, effects of PEG length and localization was investigated by ellipsometry, circular dichroism, nanoparticle tracking analysis, and fluorescence/electron microscopy. PEGylation of KYE28 reduces peptide binding to lipid membranes, an effect accentuated at increasing PEG length, but less sensitive to conjugation site. The reduced binding causes suppressed liposome leakage induction, as well as bacterial lysis. As a result of this, the antimicrobial effects of KYE28 is partially lost with increasing PEG length, but hemolysis also strongly suppressed and selecticity improved. Through this, conditions can be found, at which the PEGylated peptide displays simultaneously efficient antimicrobial affects and low hemolysis in blood. Importantly, PEGylation does not markedly affect the anti-inflammatory effects of KYE28. The combination of reduced toxicity, increased selectivity, and retained anti-inflammatory effect after PEGylation, as well as reduced scavenging by serum proteins, thus shows that PEG conjugation may offer opportunities in the development of effective and selective anti-inflammatory peptides.