While contemporary numerical weather prediction models represent the large‐scale structure of moist atmospheric processes reasonably well, they often struggle to maintain accurate forecasts of small‐scale features such as convective rainfall. Even though high‐resolution models resolve more of the flow, and are therefore arguably more accurate, moist convective flow becomes increasingly nonlinear and dynamically unstable. Importantly, the models' initial conditions are typically sub‐optimal, leaving scope to improve the accuracy of forecasts with improved data assimilation. To address issues regarding the use of atmospheric water‐related observations – especially at convective scales (also known as storm scales) – this article discusses the observation and assimilation of water‐related quantities. Special emphasis is placed on background error statistics for variational and hybrid methods which need special attention for water variables. The challenges of convective‐scale data assimilation of atmospheric water information are discussed, which are more difficult to tackle than at larger scales. Some of the most important challenges include the greater degree of inhomogeneity and lower degree of smoothness of the flow, the high volume of water‐related observations (e.g. from radar, microwave and infrared instruments), the need to analyse a range of hydrometeors, the increasing importance of position errors in forecasts, the greater sophistication of forward models to allow use of indirect observations (e.g. cloud‐ and precipitation‐affected observations), the need to account for the flow‐dependent multivariate “balance” between atmospheric water and both dynamical and mass fields, and the inherent non‐Gaussian nature of atmospheric water variables.