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UPDATE 2-New virus strain fears send German govt bonds rallying

* Safe-haven German bonds rally on new COVID-19 strain fears

* Inflation expectations slide

* Italy’s risk premium touches highest level since Dec. 11 (Updates prices)

AMSTERDAM, Dec 21 (Reuters) - Safe-haven German bond yields dropped on Monday and set their biggest decline in over a week as a new strain of the coronavirus and lack of progress on sealing a Brexit deal hurt risk appetite, boosting demand for safe-haven assets.

Several countries imposed travel restrictions to and from the United Kingdom on Sunday due to concern over the new variant of the virus that is spreading rapidly there.

Britain and the European Union were unable to reach a deal by a Sunday deadline set by the European Parliament, though negotiations were expected to continue on Monday.

The news boosted safe-haven assets such as the U.S. dollar and government bonds, while European stocks took a beating.

German 10-year yields were last down 1.5 basis points to -0.62%, setting their biggest daily drop since Dec. 11.

A key gauge of long-term euro zone inflation expectations fell to its lowest level since Dec. 11 at around 1.23%.

“I think everyone is really fearing a much quicker spread of the coronavirus, so this is weighing on the markets,” said Rene Albrecht, rates strategist at DZ Bank in Frankfurt.

The new strain has already been identified in euro zone countries including the Netherlands and Italy.

Albrecht said the virus mutation came as a reminder that vaccines would not change life under COVID-19 very quickly.

Successful vaccine trial results from a number of drugmakers have raised hopes for a swift economic recovery, boosting risk assets and supporting investor bets on reflation trades in recent weeks.

Albrecht noted that German 10-year yields have retraced most of their rise since Pfizer Inc first announced its COVID-19 vaccine was highly effective.

That had pushed the yield as high as -0.456% by Nov. 11 from a low of -0.644% on Nov. 9 prior to the news.

On Monday, riskier Southern European yields were between flat and up 1 basis point.

The relative underperformance of Italian bonds against Germany pushed the closely watched gap between their 10-year yields - the risk premium on Italian debt - to as high as 115 basis points, its highest since Dec. 11.

“With no flow support from the ECB as purchases pause, peripherals look vulnerable with investors possibly preferring to secure performance ahead of year-end, and the market preparing for the usual supply wave in January,” Commerzbank rates strategist Rainer Guntermann told clients.

The European Central Bank’s bond buying - the key factor holding down borrowing costs in southern European countries - stopped from Monday until Dec. 29 as market liquidity drops sharply around the Christmas holidays.

News that the U.S. Congress finally reached a deal on a COVID-19 aid package failed to boost risk assets on Monday. (Reporting by Yoruk Bahceli in Amsterdam Editing by Matthew Lewis)

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