UK 2-year gilt yield hits record low after new COVID crackdown

LONDON (Reuters) - The yield on two-year British government bonds fell to a record low on Monday after the government imposed tougher coronavirus restrictions, raising fresh fears about the outlook for Britain's economy.

The yield on two-year gilts - which is sensitive to speculation about Bank of England interest rates - fell as low as -0.161% before recovering to -0.138% at 1017 GMT, down about six basis points on the day.

Prime Minister Boris Johnson imposed tougher curbs on London and southeast England on Sunday to slow the spread of a more transmissible variant of the coronavirus, and his health minister said the country "had a long way to go to sort this."

Several countries in Europe cut transport ties to the United Kingdom, adding to the deep uncertainty facing the British economy ahead of the Dec. 31 deadline for a post-Brexit trade deal with the European Union.

Britain is on course to suffer its biggest economic contraction in three centuries this year, and its recovery is expected to be among the slowest for leading economies around the world.

Benjamin Nabarro, an economist with Citi, said the travel ban, including a suspension of freight transport between Britain and France, would aggravate the Brexit hit which Citi estimates will wipe 2% off Britain's economy in 2021.

"This risks compounding the costs of Brexit, and that is going to be the bigger shock," Nabarro said.

The yield on 10-year gilts fell more than seven basis points to as low as 0.171%, its lowest since Dec. 11. Comparable German government bonds fell by less.

Sterling slumped by nearly 2% against the U.S. dollar.

The BoE kept interest rates and its bond-buying plans unchanged last week. It is looking at the feasibility of taking rates below zero for the first time.

Interest rate futures on Monday showed investors were betting on a cut to Bank Rate below zero in May next year.

Nabarro at Citi said that he expected any move to negative rates was only likely later in 2021 and that the BoE was likely to keep its bond-buying programme as its main stimulus tool for the time being.

(Writing by William Schomberg; Editing by Kate Holton)