19.08.201910:29 Forex Analysis & Reviews: Sterling volatility will increase, cautious base-building in evidence

After trading higher in early Europe on Monday, GBP/USD retreated to 1.2130 after failing to break 1.2170 while EUR/GBP strengthened to 0.9155 from 0.9120.

There are no major UK data releases during the week with political developments liable to dominate as markets monitor three crucial strands.

Prime Minister Johnson is scheduled to meet German Chancellor Merkel on Wednesday and French President Macron on Thursday. These meetings will be held ahead of the G7 Summit which starts on Friday in France.

The tone of rhetoric in these bilateral meetings will have an important impact on the sterling sentiment with an antagonistic tone from Johnson likely to be received badly within the EU. Expectations are, however, low and conciliatory rhetoric would provide an element of support to the sterling.

Within the UK, markets will focus on attempts by MPs to block the possibility of a disorderly EU exit at the end of October. After media leaks over the government's assessment of the 'no-deal' risks, markets will also try to reckon the likely impact on the UK economy of any EU departure without a deal.

CFTC data recorded a small decline in short, non-commercial sterling positions, but the total remained close to 100,000 contracts and the second-highest short positon since April 2017. Immediate selling pressure has eased slightly in derivatives markets and there will be scope for significant short covering on any shift in sentiment.

Liquidity levels will remain low during the next two weeks with the peak holiday season in the UK and the EU, increasing the potential for a short squeeze and maintaining the risk of choppy trading.

Interestingly, the sterling outlook has improved after solid economic data releases last week. The UK currency will also gain an element of protection from expectations that the Federal Reserve and ECB will both advocate for further monetary easing in September.