Former journalist Katelin McInerney comfortably won the NSW south coast seat of Kiama over the weekend, with Labor's two-party preferred vote about 60 per cent.
The victory bolsters the minority Labor government's position while adding to pressure on Opposition Leader Mark Speakman.
But he is "supremely confident" there will not be a challenge to his leadership.
"There are a lot of armchair commentators, my focus is not on their chatter," he told ABC Radio Sydney on Monday.
The by-election loss was disappointing, but not unexpected.
"Kiama is a special case," Mr Speakman said.
Gareth Ward's 14-year hold on the seat ended in August when he resigned as parliament was preparing to expel him.
His legal bid to hold the seat after being convicted of sexual and indecent assaults failed.
Ward first won the long-time Labor seat for the Liberal party in 2011, retaining it as an independent in 2023 after being charged.
Liberal candidate Serena Copley garnered 26 per cent of first-preference votes on Saturday, which would see the party "lose a whole swag of seats" if replicated statewide in 2027, Mr Speakman said.
"That's why I want my MPs out there listening to communities every day," he said.
But Mr Speakman did not accept the result meant his leadership was on borrowed time.
"I am the best person for the job.
"I'm not going to be distracted by anonymous gossip."
Premier Chris Minns said the circumstances of the by-election were "pretty unique".
"The incumbent member's sitting in jail," he told ABC Radio Sydney.
But Labor's return to the seat, which it held for three decades before Ward's election, was not a "pat on the back for the government".
"It was just an invitation to work harder," Mr Minns said.
The Kiama result was followed by disastrous polling for Mr Speakman's federal colleagues.
The coalition is number-one in only 27 per cent of voters' minds, the lowest primary result since Newspoll began tracking first preferences in 1985.
That laid the foundation for Labor's Anthony Albanese taking a commanding 58-42 two-party-preferred lead.
The grim figures were echoed in the latest Resolve Political Monitor, which also found one in six NSW voters rank One Nation highest following national anti-immigration protests and coalition division over migration policy.
But former Liberal minister David Elliott warned against Vaucluse MP Kellie Sloane - seen as a future leader of the NSW Liberals - instigating a challenge to Mr Speakman.
"The ones that are backing in Kellie want Kellie to come in now so that she can be burned at the next state election," Mr Elliott told Sydeny radio 2GB.
"They want (conservative) Monica Tudehope to be the leader after."
NSW parliament resumes on Tuesday.
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