* UK economy contracts 0.2% in Q2, surprising market
* Pound hits as low as $1.2056, 92.885 pence per euro
* Graphic: World FX rates in 2019 http://tmsnrt.rs/2egbfVh
* Graphic: Trade-weighted sterling since Brexit vote http://tmsnrt.rs/2hwV9Hv (Updates prices, adds quote and more context)
By Olga Cotaga
LONDON, Aug 9 (Reuters) - Sterling skidded again on Friday, hitting its lowest in more than two years, after an unexpected second quarter contraction in the economy alarmed investors already fretting that Britain is headed for a no-deal Brexit.
The pound, which has lost 3.7% of its value against the dollar since arch-Brexiteer Prime Minister Boris Johnson's arrival in office in late July, sank to $1.2056, the weakest it has been since January 2017, and was last down by 0.5% at $1.2072.
Against the euro, the pound slid to a new two-year low of 92.885 pence and was last down by 0.7% on the day.
The British currency has been close to being the worst performing in the developed world these past couple of weeks since Johnson became prime minister on July 24.
Britain's economy shrank at a quarterly rate of 0.2%, the first contraction since 2012 and below all forecasts in a Reuters poll.
Year-on-year economic growth slid to 1.2% from 1.8% in the first quarter, Britain's Office for National Statistics said, its weakest showing since the start of 2018.
British government bond yields fell as investors sought safety in fixed income assets.
UK domestic stocks weakened, although London's export-heavy blue chip FTSE 100 index clawed its way back into positive territory as sterling plunged.
Some investors now expect Britain to enter a technical recession, which represents two consecutive quarters of negative growth, if the economic situation continues to worsen.
"Overall, these are clearly a disappointing set of figures which have significantly raised the likelihood of a technical recession," said Azad Zangana, senior European economist and strategist at Schroders.
The pound has suffered a torrid few weeks as investors priced in the growing risk of Britain exiting the European Union under Johnson on Oct. 31 without a deal to smooth the transition.
BNP Paribas raised on Friday the probability of a no-deal Brexit to 50% from 40%. Some analysts say there could be more pain to come.
"As the political risk premium rose, sterling was the worst-performing major currency in each of May, June and July, but the negative risk premium can still rise further," RBC Capital Markets analyst Adam Cole said.
Johnson is planning to hold a parliamentary election in the days after Brexit if lawmakers sink the government with a no-confidence vote, British media have reported, further unnerving currency traders.
It is growing increasingly likely that Johnson will face a vote of no confidence soon after Sept. 3, when parliament returns from its summer recess, analysts say.
Johnson says Britain, which voted for Brexit in 2016 by a 52%-48% margin, must leave the EU on schedule on Oct. 31, with or without a divorce deal with the bloc. Delaying an election until after Brexit could be a tactic to ensure that happens even if parliament withdraws support for his government.
Vasileios Gkionakis, global head of forex strategy at Lombard Odier, said he was worried about an election, but was also ready to unload some sterling short positions he had accumulated since a lot of bad news had been already priced in.
"If no-deal (Brexit) increases in probability, then of course sterling would be a sell, but until then Iâ€™m becoming a bit more neutral," Gkionakis said, adding that he expects sterling to "settle around $1.20" before market participants reassess their expectations of that outcome.
Others in the market mirrored Gkionakis' views on Friday.
Paul Hollingsworth, senior European economist at BNP Paribas, said he was "reluctant to enter short sterling positions" and that he found "risk-reward more attractive to consider entering structural long sterling positions as we get closer to September".
The shrinking economic growth in the second quarter did not make investors more confident that the Bank of England will cut interest rates in September. Some economists expect the central bank to embark on more easing soon, however.
"As uncertainty continues to loom over the UK economy, the difficult run of data is expected to continue and the BoE will need to consider its next step carefully as its global peers embark on further rate cuts," said Geoffrey Yu, head of the UK Investment Office at UBS Wealth Management.
Money markets are pricing in a 25 basis point cut by January 2020.
(Reporting by Olga Cotaga with additional reporting by Tommy Wilkes Editing by Mark Heinrich)