UPDATE 1-Sterling rallies as PM May's Brexit deal defeat fuels uncertainty

Sterling rallied more than a cent from the day's lows against the dollar on Tuesday after British lawmakers overwhelmingly defeated Prime Minister Theresa May's Brexit divorce deal.

With the 230-vote margin of defeat far more than what markets were anticipating, the pound rallied on some expectations that the scale of the defeat might force lawmakers to pursue other options.

But analysts warned against reading too much into the bounce. Tuesday's defeat opens an array of options, including a vote of no confidence called by the opposition Labour leader Jeremy Corbyn, to be held at 1900 GMT on Wednesday.

"UK assets will continue to be vulnerable to the political volatility and we don't expect this will subside until a concrete conclusion emerges," said Dean Turner, UK economist at UBS Global Wealth Management.

Parliament voted 432-202 against May's deal, the worst parliamentary defeat for a government in modern British history. Scores of her own lawmakers - both Brexiteers and supporters of EU membership - joined forces to vote down the deal.

The pound which was down as much as 1.2 percent before the vote, was briefly down 1.5 percent before rebounding sharply $1.2823, down 0.4 percent on the day.

The speed of the rebound also reflects large underlying short positions in the currency markets, which many investors chose to unwind before fresh political developments.

"MASSIVE UNCERTAINTY"

"The sterling rebound may also simply be short-covering as there is still a massive amount of uncertainty for UK assets," said Eric Stein, co-director of global income group at Eaton Vance in Boston.

While the pound has been supported in recent days on growing expectations that Britain will avoid a 'no-deal' Brexit, Tuesday's defeat offers no clear path ahead.

With the clock ticking down to March 29, the date set in law for Brexit, the country is now ensnared in the deepest political crisis in half a century.

The sharp fluctuations in the pound also fuelled volatility in UK-focused exchange-traded funds. A U.S-listed MSCI UK ETF was up as much as 0.4 percent.

"The two big takeaways for markets from this are that, one, this deal is dead and, two, lawmakers might have to explore other creative options to avoid a no-deal Brexit," said Timothy Graf, head of macro strategy at SSGA, based in London.

(Reporting by Saikat Chatterjee; Editing by Janet Lawrence)

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