A vote by U.K. lawmakers on Thursday will make it harder for Britain's next prime minister to try to force a no-deal Brexit, a move which rallied the pound, but market watchers believe it is increasingly likely Britain will crash out of the European Union without a deal by the end of October.

Economists at Berenberg, who now assign a 40pc probability of a hard Brexit, say the decision by Boris Johnson, the favourite to succeed Prime Minister Theresa May, to surround himself with hardline eurosceptics is an indicator of such growing risks.

"By surrounding himself with hardliners, Johnson could find himself boxed into a hard Brexit with little room for manoeuvre," they wrote in a note.

In addition, Britain could face more political turmoil because the new prime minister may find it difficult to back up campaign pledges, given the government's is reliant on a smaller party for a slim majority in parliament. That in turn could spark a general election, hurting the pound, analysts say.

"The latest developments support our view that a snap general election is becoming the most likely way to break the Brexit deadlock in parliament," said Lee Hardman, currency analyst at MUFG.

"In these circumstances, we still believe the pound should continue to trade on a weaker footing heading into the crunch autumn period," he said.

On Friday, those concerns dominated sentiment with the pound weakening 0.3pc to $1.2499 and 0.1pc versus the euro to 89.74 pence.

Investors had dumped the pound earlier this week, sending sterling to a 27-month low against the dollar and a six-month low versus the euro, before recovering some of those losses on Thursday.

Derivative markets also signalled a similar degree of unease with implied volatility on the pound for three month maturities rising to its highest levels since early April.