Prime Minister Boris Johnson's government on Tuesday ruled out an extension to the December 2020, deadline for negotiations on a trade deal with the European Union, creating a new Brexit cliff-edge and cutting short sterling's post-election rally.
The pound fell on the news and has collapsed more than 3pc from an 18-month high of $1.2516 struck after Johnson's landslide victory in Thursday's general election.
It was last down 0.2pc versus the dollar, at $1.3105 . Against the euro it was down around 0.2pc at 85.02 pence.
"This is a correction of the election euphoria, slowly but surely, as the realisation sets in that this whole Brexit drama is not over yet and just another deadline of a hard Brexit will be looming eventually at the end of the year," said Thu Lan Nugyen, FX strategist at Commerzbank.
She said Brexit had come back onto the agenda more quickly than she had expected.
Johnson's Withdrawal Bill is due to be debated in parliament, where he now has a majority, on Friday.
Nguyen put an 80pc probability on the chances of the plan to outlaw an extension to the negotiating period passing.
Nugyen said it was too early to assess the renewed risk of a hard Brexit, but the fact that Johnson missed his Oct. 31 "do or die" deadline for exiting the EU suggests that this Dec. 2020, deadline could also be extended.
This means Brexit will be in focus at the Bank of England's meeting on Thursday.
"At least temporarily the market surely will be looking at the BOE, to get an idea of how to assess this Brexit risk -- they have to make a statement about this as well," Nguyen said.
Bank of England Governor Mark Carney warned on Tuesday evening that monetary policy tools risk becoming ineffective unless there is better cooperation from governments on trade and fiscal policy.
"Recent economic data releases from the UK suggest that the BoE will maintain a cautious stance tomorrow despite some grounds for optimism following the election," MUFG analysts wrote in a note to clients.