LONDON- Investors accepted record-low returns in exchange for protection from British inflation over the coming decade when they bought an index-linked government bond at auction on Thursday, reflecting the political tumult gripping the country.

Demand for British linkers spiked as investors bet that a weaker pound will follow from Brexit ructions in Westminster, something which would push inflation higher, like after the 2016 referendum.

Prime Minister Theresa May was clinging on to power on Thursday after her final Brexit gambit backfired, pushing sterling to new five-month lows against the U.S. dollar. GBP/

May's departure could deepen the uncertainty around Brexit as a new leader is likely to want a more decisive split with the European Union, raising the chances of a more confrontational tack with the bloc and another general election. 

At an auction on Thursday, Britain's Debt Management Office received bids worth 2.39 times the 1.25 billion pounds ($1.58 billion) of the 0.125% 2028 index-linked gilt GBIL0E28= on offer, the highest bid-to-cover ratio for a linker auction since January 2018.

Signifying the strength of demand - as well as the subdued outlook for growth and interest rates in Britain and abroad - the auction generated a negative real yield of -2.326%, the lowest since Britain first sold index-linked gilts in 1981.

This means investors will be paid a coupon 2.326 percentage points below the rate of retail price inflation, which stands at 3.0%, and RPI will need to average more than 3.3% over the life of the bond for it to pay more than a conventional 10-year gilt.

"If you're talking about a weaker sterling because of the politics, the economy not doing so well, you'll probably be thinking about a situation where inflation might well go up," Marc Ostwald, chief strategist at ADM Investor Services, said of the appeal of linkers right now.

He added that demand had been boosted further by an influx of twice-yearly coupon payments from November-dated linkers, 11 in total, which pay out this week.

In the cash market, the real yield on the 2028 linker sold at auction was down around half a basis point on the day at 1142 GMT, in line with similar inflation-linked bonds 0#GBTSYIL= .

The benchmark 10-year conventional government bond yield stood 3 basis points lower on the day at 0.99%, having earlier hit 0.981%, its lowest since March 29.

The gap between British and German 10-year yields narrowed to its lowest level since April 5 at 107.9 basis points, down just over a basis point on the day. ($1 = 0.7911 pounds)

(Reporting by Andy Bruce; Editing by Alison Williams) ((andy.bruce@thomsonreuters.com; +442075423484; Reuters Messaging: andy.bruce.thomsonreuters.com@reuters.net))