Britain has sold a government bond with a negative yield for the first time after plunging inflation raised the prospect of the Bank of England cutting official interest rates below zero.

In a development that effectively means investors have to pay to lend money to fund the government’s response to the Covid-19 pandemic, investors bought gilts knowing they would get back less than they paid for them when the bonds mature in three years’ time.

The debt management office (DMO) said it had sold £3.8bn of three-year gilts at a yield of -0.003%, with the result that Britain has joined a small group of countries – such as Germany and Japan – that have persuaded investors to accept a negative return.

In 2016 the UK sold a one-month treasury bill for a negative yield but this is the first time a longer-term bond has sold for a return below zero.

Yields on gilts with a short maturity date are sensitive to City expectations about the future path of interest rates, and the drop in the annual inflation rate from 1.5% to 0.8% fuelled speculation that the Bank might further reduce the official cost of borrowing from its historic low of 0.1%.

The Bank’s governor, Andrew Bailey, has made it clear that negative rates – which affect the profits of the commercial banks – are not likely to be the first resort of the Bank if it feels the need to provide further stimulus to the economy but the issue is being discussed by Threadneedle Street’s monetary policy committee.

The DMO is holding frequent gilt auctions to pay for the extra government borrowing resulting from the effective shutdown of the economy.

Despite concerns that the government would have to offer higher yields to investors to persuade them to finance the highest borrowing in peacetime, demand for gilts has been strong.

According to the DMO, bids for the July 2023 gilt were worth £8.1bn – more than double the £3.75bn on offer.

Kit Juckes, a macro strategist at Société Général, said it would be a bad idea for the Bank to lower rates below zero. “Personally, I can’t think of an economy where negative rates are a worse idea than the UK.

“The chancellor has dramatically increased government borrowing and the Bank of England is buying the economy time by mopping most of it up”, he said. “How on earth does it make sense to even consider adding negative rates to the mix?”