Above: Labour Party leader ahead of talks with Prime Minister Theresa May. Image © Pound Sterling Live, BBC News

- Chinese data is main driver of FX markets in early mid-week trade

- Speculation on state of Labour-Conservative Brexit talks is rife

- Inflation data comes in softer than forecast

- Pound-to-Euro exchange rate @ 1.1550

- Pound-to-Dollar exchange rate @ 1.3062

The British Pound is trading lower against the Euro in mid-week trade but is recording a gain against a dour U.S. Dollar.

Sterling's gains against the Greenback and losses against the Euro come courtesy of an important global development: some better-than-forecast Chinese GDP data that appears to have stimulated a broadly positive global investor tone that aids the Euro but weighs on the Dollar.

Investors cheered news that Chinese GDP grew 6.4% year-on-year, ahead of expectations for growth of 6.3% while the country's industrial production grew an impressive 8.5% year-on-year, ahead of expectations for growth of 5.6%.

The China-focussed Australian Dollar and New Zealand Dollar appear to be the winners of the news, and we are seeing the GBP/AUD and GBP/NZD exchange rates down a third of a percent as a result.

When markets are in a buoyant mood the 'safe-havens' such as the Japanese Yen, Swiss Franc and U.S. Dollar tend to fall, hence the GBP/USD exchange rate's gain to 1.3062 amidst the broadly softer Dollar environment.

"USD eased in the Asian session following the stronger than expected Chinese economic data," says Kim Mundy with CBA. "A sustained improvement in the Chinese economic outlook is now looking more likely".

But, the Euro is a notable beneficiary as traders are betting that the Eurozone's recent soft patch will be coming to an end. The Eurozone economy has struggled since the second-half of 2018 thanks in large part to a slump in German exports.

There are multiple causes behind the slump, but a global slump in trade appears to be a main culprit.

Therefore, expectations for a Chinese-lead recovery in global trade leaves Germany exposed to a recovery, and the Euro understandably likes this idea.

State of Labour-Conservative Talks Subject to Speculation

For the Pound-to-Euro exchange rate - which is considered the purest barometer on Brexit sentiment - focus remains on Brexit, even if headlines on the topic are becoming harder to find.

Foreign exchange markets have been reportedly unnerved by reports over the course of the past 24 hours that Brexit talks between the Labour Party and UK government have broken down.

A report in the Guardian newspaper had stated talks had stalled due to a Conservative desire for post-Brexit deregulation including pursuing a U.S. trade deal.

"There has to be access to European markets and above all there has to be a dynamic relationship to protect the conditions and rights that we’ve got for environment and consumer workplace rights," Corbyn said according to the Guardian.

The news was widely cited by foreign exchange commentators as being the cause of a lacklustre performance by Sterling on Tuesday.

"Adding to the Brexit‑related decline in GBP/USD, media reports are suggesting the Government’s Brexit talks with Opposition leader Jeremy Corbyn have stalled," says CBA's Mundy, "GBP/USD will remain sensitive to Brexit developments."

However, when asked by Reuters, an official Labour Party spokesman did deny the Guardian report, saying that further meetings were planned for this week and next.

The episode appears to be symptomatic of a market and commentariat that is grasping at any news on Brexit at a time when the headlines have dried up owing to the provision last week of a lengthy extension in the Brexit process to October 31.

We expect the British Pound to remain highly sensitive to Brexit news-flow over coming days and weeks and will not be surprised if we see bouts of volatility on rumours and counter-rumours.

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Inflation Data Disappoints

Aiding the softer tenor to Sterling in mid-week trade is the release of UK inflation data, which came in on the soft side.

Headline CPI inflation for March read at 1.9% reports the ONS, but was forecast to have increased 2.0% year-on-year.

The deviation from expectation was to the downside, and we are seeing some signs - albeit small signs - that the data has weighed on the UK currency.

The Bank of England will feel that with inflation not threatening a breakout higher there is little reason to rush in an interest rate rise in 2019.

Above: The trend in UK inflation has been to the downside of late.

The Bank is mandated to keep price rises around the 2.0% levels, and the rule-books suggests that when inflation threatens to fall sharply the Bank cuts interest rates and when inflation is threatening to materially breach the 2.0% level they raise interest rates.

Rising interest rates meanwhile tend to be positive for Sterling as foreign investors divert capital to where yields are expected to increase, while the currency tends to fall when the opposite is true.

Therefore, because today's inflation data came in on the soft side it is bearish for the Pound.

However, with Brexit being the main focus for Sterling at present we argue that any deviation from the expected 2.0% would have to be surprisingly large to sustain any sizeable move in the Pound.

We would also suggest that any moves in the currency following the inflation release will ultimately be short-lived.

"March CPI data might trigger some Sterling volatility today. However, it won’t change the Bank of England's assessment. In a broader perspective we stay cautious on sterling as long as Brexit and the political impasse drags on," says Mathias Van der Jeugt, an analyst with KBC Markets in Brussels.

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