* Dust settles after pound’s volatile reaction to Brexit vote
* Market eyeing potential extension of March Brexit deadline
* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh (Adds details and quotes, updates prices)
By Shinichi Saoshiro
TOKYO, Jan 16 (Reuters) – The pound steadied on Wednesday but remained on the backfoot following a volatile overnight session after British lawmakers defeated Prime Minister Theresa May’s Brexit divorce deal by a crushing margin.
Parliament on Tuesday 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 by lawmakers later in the day.
Sterling had sunk more than 1 percent against the dollar earlier on Tuesday 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, caught in a narrow range after gyrating between a low of $1.2670 and a high of $1.2917 during the previous session.
“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,” said Yukio Ishizuki, senior currency strategist at Daiwa Securities.
“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 date set in law for Brexit is March 29, but with the clock ticking down quickly an extension of the deadline now appears more likely.
Against the euro, the pound was little changed at 88.70 pence after gaining about 0.4 percent overnight.
The euro inched down 0.1 percent to $1.1398 following a loss of 0.5 percent the previous day.
The dollar eased 0.15 percent to 108.520 yen after advancing 0.5 percent against its Japanese peer overnight amid a further ebb in risk aversion with U.S. stocks posting strong gains.
The Swiss franc, which tends to gain in times of political tensions and market turmoil along with the yen, also sagged.
The franc lost 0.7 percent against the U.S. currency and last held steady at 0.9879 franc per dollar.
The dollar index against a basket of six major currencies was effectively unchanged at 96.017 after climbing almost 0.5 percent the previous day, when it brushed an 11-day high of 96.261.
“A recovery by U.S. equities and a resulting ebb in downward pressure on Treasury yields will widen interest rate differentials between the United States and other countries. This will be a theme supporting the dollar this year,” said Junichi Ishikawa, senior FX strategist at IG Securities in Tokyo.
Long-term U.S. Treasury yields dropped to an 11-month low of 2.543 percent at the start of January but have bounced back above 2.70 percent, as the broader equity markets have regained some calm after experiencing a heavy round of risk aversion seen at the turn of the year.
The Australian dollar was slightly lower at $0.7197 after dipping 0.2 percent on Tuesday. (Editing by Shri Navaratnam & Kim Coghill)