14.08.201910:58 Forex Analysis & Reviews: UK inflation data underpins sterling, sell EUR/GBP on rallies

Tuesday's labour market data was mixed with unemployment increasing to 3.9% from 3.8% while there was a larger-than-expected increase in employment to fresh record highs.

Average earnings data beat market expectations with a headline increase of 3.7% in the year to July while the core rate strengthened to an 11-year high of 3.9% from 3.6%.

The CPI inflation rate increased to 2.1% for July from 2.0% previously and above expectations of 1.9%. The core inflation rate also increased to 1.9% from 1.8% the previous month.

The combination of strong wages growth and a higher-than-expected inflation rate will make it more difficult for the Bank of England to justify any cut in interest rates, especially as the impact of recent sterling's weakness has not shown up yet in the inflation data.

The sterling ticked higher after the inflation data, but EUR/GBP remains above 0.9250 with GBP/USD near 1.2070.

Political factors still dent market sentiment on the sterling as markets are still fretting over the risk of a 'no-deal' Brexit at the end of October.

The government is pushing ahead with an aggressive stance towards the EU and demanding major concessions on the Northern Ireland backstop. Prime Minister Johnson insists that the UK will leave on October 31^st with or without a deal.

There are major divisions within the Conservative Party and there is the likelihood of a major battle within the House of Commons when parliament returns from recess at the beginning of September.

The underlying sentiment on the pound sterling will remain very fragile while these political fears continue.

The euro zone, however, also faces serious risks from Brexit as well as a political crisis in Italy. Second-quarter data also confirmed that the German economy contracted in the second quarter.

However, there will be an important lack of liquidity over the next two weeks during the peak holiday season. Therefore, there will be an increased threat of position squeezes and very choppy trading.