TOKYO, Dec 20 (Reuters) - Japan's main stock market gauge closed at a more than two-month low on Tuesday and the benchmark 10-year government bond yield rose to seven-year highs after the central bank caught investors off-guard by letting long-term interest rates to rise.

The Nikkei share average tumbled 2.46% to close at 26,568.03, its lowest since Oct. 13 in its sharpest daily decline since Oct. 11.

The broader Topix lost 1.54% to 1,905.59.

The 10-year JGB yield rose 21 basis points to 0.460%, its highest since 2015, after the BOJ unexpectedly decided to allow the yield along the benchmark curve to move 50 basis points either side of its 0% target, wider than the previous 25 basis point band.

"I had expected the 10-year yield to hit 1% when the BOJ tweaks its policy, but it didn't and that's because the BOJ conducted emergency bond buyings to contain elevated yields," said Masayuki Koguchi, general manager at the fixed income investment division of Mitsubishi UFJ Kokusai Asset Management.

The five-year yield rose to as high as 0.260%, its highest since September 2013. JGB futures fell, triggering a trading halt, down 1.72 point.

"This is a step that the BOJ would have to take eventually but the market did not expect this could happen this soon," said Shigetoshi Kamada, general manager at the research department at Tachibana Securities.

"Until now, Japanese shares were firm compared with Wall Street. But going forward they will be part of the trend for major global stocks."

Technology investor SoftBank Group slipped 4.85% and was the biggest drag on the Nikkei, followed by chip-making equipment Tokyo Electron, which fell 3.53% and its peer Advantest slumped 2.98%. Uniqlo brand owner Fast Retailing reversed course to end 1.86% lower.

All but four of the 33 industry stock sub-indexes on the Tokyo Stock Exchange fell.

The banking sector rose 5.12%, highlighting the relief for investors from the BOJ decision after years of ultra-low rates pressured the industry's core earnings from loans and deposits.

The insurance sector gained 4.49% and brokerages was up 0.21%. Utilities rose 0.45%.

"It was a nice move, including the fact that it came against the economists' expectations. The current policy framework would have mandated an endless bond-buying if everyone expects (a shift)," said Hiroshi Namioka, chief strategist and fund manager, T&D Asset Management. (Additonal reporting by Ankur Banerjee in Singapore and Makiko Yamazaki in Tokyo; Editing by Sherry Jacob-Phillips, Rashmi Aich & Shri Navaratnam)