Ratings upgrade, Renzi optimism drive Italy's yields to eight-year lows
* Italy 10-year yields hit 8-year lows
* Centre-left leader Renzi poised to lead new government
* Moody's move on ratings outlook underpins firm tone
LONDON, Feb 17 (Reuters) - Italian bond yields hit eight-year lows on Monday following Moody's lifting of its outlook on the country's credit rating to "stable" from negative and as Rome prepared for a new government.
The rating agency's move, late on Friday, came after centre-left leader Matteo Renzi led the ouster of his party rival Enrico Letta as prime minister, a move largely welcomed by investors encouraged by Renzi's pledge for more ambitious reform.
Moody's said in a statement it had improved its outlook on the euro zone's third largest economy on the back of Italy's financial resilience, falling funding costs and diminished risk that the state may have to use resources to help recapitalise its banks. It affirmed its rating at Baa2.
"We were underweight Italy but we bought back this morning after the Moody's decision," said Tanguy Le Saout, head of European fixed income at Pioneer Investments, adding he now had a neutral position on Italian bonds.
"I have a hard time being long Italian bonds, they've had a great rally and there's not much juice left."
Italian 10-year yields fell 6 basis points to 3.62 percent, a level last seen in February 2006 and half their crisis peaks. They extended last week's fall spurred by bets that a Renzi government could do more to revive an economy that has lagged euro zone peers. Their risk premium over German benchmark Bunds is back near three-year lows around 193 bps.
The 39-year-old mayor of Florence is due to start talks to form a government within the next 24 hours before seeking a formal vote of confidence in parliament, possibly later this week.
He said he expected to lay out full reforms to Italy's electoral law and political institutions by the end of the month, to be followed by labour reforms in March, an overhaul of the public administration in April and a tax reform in May.
Markets have given him the benefit of the doubt.
"He's a popular guy, which helps if you're looking for someone to introduce more assertive policy," said Chris Scicluna, head of economic research at Daiwa Capital Markets.
Renzi has a difficult task ahead.
Data last week showed the economic recovery in Italy lagging that of the euro zone in the fourth quarter. Improving its growth prospects is key to the country's attempts to curb its 2 trillion euro debt load.
"Obviously Renzi is taking a gamble but it's a calculated risk. Doing nothing was the worst possible strategy for Italy ... There's a sense Italy cannot waste any more time," said Riccardo Barbieri, a strategist at Mizuho.
"This sense of urgency is the driver of some of the decisions Renzi took recently. He probably thought it was time for action and he is doing it the only way he thinks is possible by taking control to try to move the reform agenda forward."
Moody's said an upgrade of Italy's rating could not be ruled out in the event of "an effective strengthening of the economy's growth prospects triggered by the successful implementation of economic and labour market reforms".
Some analysts cautioned, however, that the manner in which Renzi took over and his stronger hand risked turning his coalition partners against him in the longer run. Fitch, Moody's competitors, said Renzi was likely to face similar challenges to Letta in a volatile political landscape.