12.08.201909:25 Forex Analysis & Reviews: Sterling sentiment bleak, beware of short squeeze

Sentiment on the sterling continued to deteriorate on Friday following the shock GDP data from the UK which recorded a 0.2% decline for the second quarter.

The data increased fears over the prospects of the UK economy, especially with industrial production also remaining weak. There was also a further shift in futures markets with increased expectations of a Bank of England rate cut this year.

In response, the sterling dropped sharply with EUR/GBP at 9-year highs above 0.9300. Besides, GBP/USD slumped to 34-month lows below 1.2050.

Political uncertainty remains a key influence with ongoing fears that the UK is heading for a 'no-deal' Brexit at the end of October.

Sentiment will remain very fragile in the short term and sellers will look to take advantage of low trading volumes during the peak holiday season to push the currency even weaker.

The House of Commons will return from recess in early September and this will be a critical period for the UK outlook.

UK lawmakers, who oppose a 'no-deal Brexit', will continue their attempts to block any government's move towards 'no-deal' and potentially force a no-confidence defeat for the government. There will also be unofficial talks between the UK and EU officials with individual EU countries. Such talks are being held very uneasy over the threat of a 'no-deal' outcome. Markets have not priced in potential damage to the EU economy.

Uncertainty will remain very high and, although this is the holiday season, there will be intense political manoeuvring behind the scenes. It is important to note that public political rhetoric is likely to be notably different from reality as background negotiations continue. The UK establishment will also step up efforts to block a disruptive Brexit outcome.

The key feature will be very choppy sterling trading in the short term, especially amid the lack of liquidity.

CFTC data recorded a further increase in short, non-commercial sterling positions to near 103,000 contracts, the highest net short position since April 2017. This positioning will maintain the risk of a sharp squeeze on shorts, especially with a lack of trading volumes.