The pound pared losses after Prime Minister Theresa May's Brexit deal was roundly defeated by U.K. lawmakers, spurring speculation Britain's exit from the European Union could be derailed.
Sterling was still on course to snap a two-day rally after May lost the vote 432 to 202, but erased more than half of the day's drop. The government must now face a vote of no-confidence initiated by the opposition Labour Party on Wednesday.
The party's leaders have said that if there is not a general election, all options, including campaigning for a second referendum, remain on the table.
"While we have bounced since, we struggle to get excited about sterling's upside here," said Ned Rumpeltin, European head of FX strategy at Toronto-Dominion Bank. "We could see some market participants begin to think that the next move will be in favor of a 'No Brexit' outcome, but there is still a lot of blue water between here and there."
The best case for a majority of investors would be another poll on whether Britain should leave the EU, which would boost the currency to $1.35, while the worst case — leaving with no deal — would see the pound drop to $1.15, according to analysts surveyed by Bloomberg.
The pound has lost around 15 percent of its value against the dollar since the U.K. voted to leave the European Union in June 2016 amid fears that the departure would badly hurt the country's economy.
Bank of England governor Mark Carney has said that Brexit could push officials to move policy in either direction, and that a no-deal outcome could lead to quicker hikes in an attempt to control inflation.
The currency fell 0.2 percent to $1.2839 after declining as much as 1.5 percent earlier. Analysts had suggested beforehand that a margin of defeat above 100 votes would be negative for the currency.
"The question now, assuming Labour fail, is whether they now default to a second referendum as party policy," said Adam Cole, chief currency strategist at RBC Europe Ltd. "That should be clear within a couple of days."
