The pound steadied early this morning but remained on the backfoot following a volatile overnight session after British politicians defeated Prime Minister Theresa May's Brexit divorce deal by a crushing margin.
The British parliament yesterday voted 432-202 against May's deal, the worst parliamentary defeat for a government in recent British history.
Investors' short-term focus is now on a confidence vote on May's government later today.
Sterling had sunk more than 1% against the dollar at one stage yesterday but rallied back after the parliamentary vote, with the sizable defeat for May seen forcing Britain to pursue different options.
However, there are also worries the outcome might trigger political upheaval that could lead to a disorderly exit from the European Union.
The pound traded a shade lower at $1.2846 this morning, caught in a narrow range after gyrating between a low of $1.2670 and a high of $1.2917 during the previous session.
Shortly after 6.15pm the euro was trading at £0.8868 - down slightly on the day against the pound.
"While the margin of May's loss was a surprise, the defeat itself was something the market had been pricing in for a long time and it appears that participants covered shorts in the pound after the vote," Yukio Ishizuki, a senior currency strategist at Daiwa Securities, said.
"The market is now factoring in the March Brexit deadline being extended. In the longer run it may boil down to two scenarios - a no-deal Brexit or no Brexit at all," the strategist said.
The date set in law for Brexit is 29 March, but with the clock ticking down quickly an extension of the deadline now appears more likely.
Meanwhile, sterling extended its gains against the euro this morning to its highest level since November.
Expectations that the scale of yesterday's defeat might force lawmakers to pursue other options has lent some support to the currency although a high degree of uncertainty remains.