Sterling surged Wednesday as British Prime Minister Theresa May repelled a leadership challenge and quieted a destructive mutiny within the U.K.'s Conservative Party.
Conservative lawmakers voted to back May in a widely followed secret ballot, though the outlook for Britain's exit from the European Union remains clouded. Against the 200 lawmakers backing May, 117 voted that they had no confidence in her leadership.
The currency jumped into the vote then pared some gains after the actual result. Sterling last traded up 0.9 percent.
Downside risks
On Tuesday morning, the prime minister confirmed the government would delay a critical Brexit vote in parliament, which had been scheduled to take place later that day.
Despite saying there was broad support for her proposed Brexit deal, May said defeat was all but certain amid concerns about the issue of the Northern Irish backstop.
But, lawmakers upset with her handling of Britain's scheduled departure from the EU sought to topple her from power on Wednesday.
"Higher volatility lowers sterling — that's been the story over the last two years," Kallum Pickering, a senior U.K. economist at Berenberg, told CNBC on Wednesday.
"In the long-term, I think sterling is still undervalued. But in the short-term, the risks are decidedly tilted to the downside," Pickering said.
No-confidence vote is 'merely a side show'
Graham Brady, the chairman of the backbench 1922 committee of Conservative lawmakers, announced Wednesday morning that at least 48 party members had sent him letters of protest — the number required to trigger a vote on her leadership.
A ballot will now be held between 18:00 and 20:00 London time Wednesday evening, the 1922 Committee said in a press release.
Sterling initially dipped into negative territory on the news, before climbing as market participants bet May would win the vote and, in the process, isolate lawmakers in her party pushing for a sudden break from the EU.
Nonetheless, uncertainty over the secret ballot appeared to cap significant gains. The pound has fallen almost 2 percent so far this trading week.
"All things considered, our best judgement is that a high degree of political upheaval and uncertainty are reflected in the value of the pound at $1.2550 vs. the dollar, but not yet a 'hard Brexit.' This level of the pound also reflects the increased odds of new elections," Stephen Gallo, European head of FX strategy at BMO Capital Markets told CNBC via email on Wednesday.
"This entire process feels like a giant labyrinth in which every single possible avenue of escape is being tested and failing. This metaphor is important because this leadership contest is merely a side show," Gallo said, before adding: "No matter what happens today, the parliamentary arithmetic regarding the current abysmal EU deal won't change."
The pound is down nearly 13 percent since the Brexit vote of June 23, 2016.
—CNBC's Thomas Franck contributed reporting.