Sterling's rebound came to an abrupt halt on Tuesday after a report that colleagues of Prime Minister Theresa May believed they had sufficient numbers to mount a no-confidence vote in her leadership.
The British pound fell to a new 20-month low of $1.2490, down more than half a percent on the day, after earlier trading above $1.26. A stronger dollar also weighed on the British currency.
British broadcaster Sky's deputy political editor cited sources saying lawmakers in May's Conservative Party were "pretty confident" they had the 48 letters needed to trigger a no-confidence vote.
Other media reported that the 48-letter requirement had not yet been reached.
Against the euro, sterling rallied to 90.555 pence , near a 3-1/2 month low.
Sterling weakness on Tuesday follows May's decision on Monday to delay a parliamentary vote on her Brexit deal. That spooked investors and sent the pound tumbling 2-1/2 cents to its lowest level since April 2017.
It traded as high as $1.2638 earlier on Tuesday, benefiting from dollar weakness.
"It's clear that Brexit will be a significant overhang for sometime. We see that in flows and valuations. The events of the last few days show you why theres caution," said Richard Turnill, BlackRock's global chief investment strategist.
"We still think a no deal is a very low probability. But the uncertainty will persist for some time."
May on Tuesday met with European leaders, seeking support for changes to her Brexit deal in a last-ditch bid to save it.
The European Union has ruled out renegotiating the divorce treaty. May's spokeswoman said the British parliament would vote on a deal before Jan. 21. If there was no satisfactory deal by then, parliament would be given a debate on the issue.
"It is impossible to say whether this is as bad as it gets for sterling, as that depends on what May gets back from Brussels and the odds of that getting through parliament," said John Marley, a consultant at FX risk manager SmartCurrencyBusiness.
Official data showed on Tuesday that British workers received their biggest pay rises in a decade in the three months to October.
The higher-than-expected pay growth was a further sign the UK labour market is shrugging off Brexit uncertainty, and the Bank of England will be keeping a close eye on whether wage pressures feed through to higher inflation.
However, with Brexit dominating trading, the pound was unmoved.
Amid the constant political wrangling, spot prices are proving very difficult for investors to predict. Buying sterling volatility has therefore remained a favourite trade.
One-week volatility is close to its highest levels this year, while the spread of one-month sterling volatility over euro volatility is the biggest since the 2016 Brexit referendum and the second widest since the euro was launched 20 years ago.
In another sign of how big Monday's selloff was in currency markets, a trade-weighted value of the pound against rivals suffered its biggest daily losses since the Brexit referendum vote in June 2016.