Why does olfactory sensation need lateral inhibition?
Here is the paper which directly answers your question.
Urban NN. Lateral inhibition in the olfactory bulb and in olfaction. Physiology &amp; behavior. 2002 Dec 31;77(4):607-12.
A few salient points:

It is true that the spatial gradient of sensory attributes is not as clear in the olfactory bulb-neuronal topography as it is at other places with lateral inhibition, but lateral inhibition still seems to serve a similar purpose in all these cases, namely sharpening the perceived stimuli. It is not settled how is this &quot;edge enhancement&quot; brought about in a nontopographical system ( &quot;...Specific inhibitory connections between groups of cells with similar receptive fields may allow for functional lateral inhibition in such nontopographic systems, but no evidence for such specificity has been provided in the olfactory system...&quot;).

Unlike say for example in the Retina, where lateral inhibition creates the on/off centres, the lateral inhibition in olfactory bulbs is more widespread. That is, the area inhibited is relatively more expansive. This fact, coupled with the highly localised excitation caused by odours, suggests that &quot;....lateral inhibition will be most effective at suppressing signals with low spatial frequency, in other words, signals that involve activation of broad regions of the olfactory bulb...&quot;. This is what I assume was meant by your source while referring to background odours.

The overall neurological effects of lateral inhibition is not settled, and the evidence is scanty. To quote the aforementioned paper, &quot;... A simple prediction for the effects of lateral
inhibition on olfactory behavior would be that impairment
of lateral inhibition should impair performance on olfactory
discrimination tasks, and perhaps that these effects should
be strongest for tasks involving discrimination of very
similar odorants. Such a result has been obtained in experiments
in the honeybee in which inhibition is blocked by
picrotoxin. However, in these experiments, the blockade
of inhibition did not affect the odor-evoked firing rate of
the cells recorded, suggesting that the impairment of discrimination
ability was independent of a broadening of
tuning curves...&quot;


Have a look at the cited paper, and the papers quoted therein, for further information.