* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh
* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv (Adds more volatility measures)
By Dhara Ranasinghe
LONDON, Jan 17 (Reuters) - The British pound rose to a two-month high against the euro on Thursday, extending recent gains on growing expectations that Britain can avoid a no-deal Brexit.
In a tumultuous week for British politics, Prime Minister Theresa May’s Brexit deal suffered a heavy defeat in parliament but she won a subsequent vote of confidence, removing some political uncertainty for now.
Although a multitude of options remain on the table, including fresh elections or even a second referendum vote, market analysts believe the risks of a hard no-deal Brexit have receded considerably despite the headlines.
The Labour Party could back a second Brexit referendum if its proposals for leaving the EU are shunned by the government and a no-deal scenario looks likely, Labour leader Jeremy Corbyn said on Thursday.
“There was an initial move higher on the Corbyn comments today to see if he is supporting a move for a second referendum,” said Lee Hardman, currency analyst at MUFG in London
“Generally the market is more optimistic that following the heavy defeat the other day that we will head towards a softer or no-Brexit outcome.”
The pound also firmed towards a two-month high against the dollar. It was trading 0.25 percent up at $1.2906 , inching towards a mid-November high of $1.2930 hit last week.
Against the euro, the pound firmed to 88.19 pence , its strongest level since late November.
Britain would vote to stay in the EU by a 12 percentage point margin if it was given another vote, the highest level since the shock 2016 Brexit referendum, a YouGov poll taken on Jan. 16, showed.
Mohammed Kazmi, a portfolio manager at UBP in Geneva, said investors were now likely to be more focused on Brexit scenarios that are becoming skewed in the direction of a softer exit from the European Union, or an extension of Article 50 that could delay the exit and pave the way for a second referendum.
“Either of these scenarios should play out positively for UK assets, especially as it is clear that cross-party consensus on a Withdrawal Agreement will lead to the government having to rule out a no-deal Brexit scenario as well, removing this fear for markets and narrowing the possible outcomes,” he said.
Indeed, trading in currency options markets show an increasing bias towards bets that Britain will extend its deadline to leave the European Union - a positive sign for sterling in the near term.
Three-month implied volatility — a measure of expected swings in the currency — a contract encompassing the end-March period, dropped to the lowest in more than two months to 11.145 vol — well off 2-1/2-year highs around 15 vol hit in December.
One-month gauges dropped below 11 vol for the first time since late-December as traders unwound some of their excessive short pound bets.
Reporting by Dhara Ranasinghe; Editing by Jon Boyle and Ed Osmond