By Tommy Wilkes and Tom Finn
LONDON (Reuters) - Sterling weakened on Monday after British Prime Minister Theresa May admitted there was not yet enough support to put her Brexit deal to a third vote, while parliament plotted to pull the process away from her government.
The pound had jumped higher earlier in the day on media reports that lawmakers would vote on Tuesday on May's twice-defeated Brexit withdrawal agreement - that had raised traders' hopes that May's deal would pass and prevent Britain from crashing out of the European Union.
But May said on Monday that she did not have the support to bring the deal to another vote.
"I'm more worried about no-deal Brexit than the market. I'm not clear what Theresa May wants and what (opposition Labour Party leader) Jeremy Corbyn wants -- these are the two main characters in this play and I can’t read them at all," said Thomas Costerg, senior economist at Pictet Wealth Management.
"The view that no-deal Brexit won't happen because there is a majority in parliament against that is a bit of simplistic view ... Accidents can happen.
"Options are narrowing and narrowing and narrowing," he said, predicting sterling would drop to as low as $1.20 with a no-deal Brexit and rise to at least $1.35-$1.40 if May's deal was passed.
With British politics at fever pitch and little clarity on how, when or even if Brexit will take place, sterling traders are struggling to navigate the blizzard of headlines. A range of outcomes remain possible including a long postponement, a no-deal exit or no Brexit at all.
Lawmakers in a series of vote on Monday - beginning at 2200 GMT - are likely to wrest control of the process from May after twice rejecting the deal she agreed with Brussels.
With the prime minister short of support - the Northern Irish party propping up her government still opposes her deal - it is not clear when she will bring her divorce agreement back to parliament.
May's ministers denied knowledge of a weekend plot to force her to give a date for leaving office.
After trading as low as $1.3162, sterling was back at $1.32 by 2050 GMT. It was 0.2 percent lower against the euro at 85.74 pence.
SHORT DELAY
The EU has said Britain can have a short delay to Brexit but May must first win parliamentary approval for her withdrawal deal from the bloc.
(GRAPHIC: One month implied vols at 3-1/2 month - https://tmsnrt.rs/2WmPyEd)
"The extension of the Brexit deadline was shorter than many had hoped and we still have the problem of what type of consensus deal lawmakers can rally around," said Michael Hewson, chief market analyst at CMC Markets in London.
Currency derivative markets signalled growing caution about the pound, with one-month risk reversals on sterling versus the euro and the dollar at multi-month highs.
An indicator of how bearish or bullish investors are on the outlook of the currency, risk reversals signal that short-term negative bets on the pound are piling up rapidly despite the broader calm in the spot markets.
Yields on British government bonds have tumbled in recent days as investors sought safety, with the yield on the 10-year Gilt falling below 1 percent for the first time since 2017.
(GRAPHIC: Gilt yields fall below 1 percent - https://tmsnrt.rs/2CClcWR)