* Investors enthused by Renzi's ambitious reform agenda
Renzi cabinet expected this weekend
By Emelia Sithole-Matarise
LONDON, Feb 19 (Reuters) - Italian borrowing costs hit eight-year lows on Wednesday as Prime Minister-designate Matteo Renzi scrambled to form a cabinet that investors hope will deliver on his ambitious reform agenda.
Investors have given the 39-year old leader of the centre-left Democratic Party the benefit of the doubt after he engineered the removal of party rival Enrico Letta from the premiership last week. Renzi accused Letta of failure to push through reforms needed to revive the economy.
Italy, whose economic recovery lags that of most other euro zone states, needs more robust growth than the 0.1 percent eked out in the fourth quarter if it is to curb a 2 trillion euro debt equivalent to 1.3 times economic output.
Renzi, who is expected to have his new cabinet in place by the weekend, has pledged reforms, including tackling the electoral and constitutional system, within four months of taking office.
Italian 10-year yields fell to 3.54 percent, their lowest since 2006, before retreating slightly to trade steady on the day around 3.57 percent, almost level with Spanish equivalents they have underperformed for most of 2014.
Italian yields have fallen almost 30 basis points since Thursday when Renzi threw down the gauntlet to Letta. An upgrade by ratings firm Moody's on Friday of the outlook on Italy's creditworthiness helped spurred the fall in yields.
"Under the previous government it didn't look like there was much chance of moving forward on reforms. Now it looks like there's a chance, maybe a small one, but still a chance of reforms," said Justin Knight, a strategist at UBS.
"We are bullish on the periphery and we expect the rally to continue and Italy will go with it."
Italy's 10-year bond yield premium over German benchmarks touched a fresh three-year low around 190 basis points, less than half levels at the height of the euro zone crisis in early 2012. Knight expects a further 20 bps fall in the premium in the coming month.
The buoyancy in Italian bonds was not evident on the stock market. Milan's FTSE MIB index was down 0.4 percent and underperforming most other European bourses.
However, the index is still up some 2.7 percent from Thursday's lows and close to levels last seen in mid-2011.
Doubts remain over whether Renzi will command the strong support from the "grand coalition" that backed Letta which he will need if he is to implement comprehensive structural reforms.
But for now, sentiment on Italian bonds remains upbeat, with demand underpinned by expectations the European Central Bank will keep monetary policy ultra-easy to fend off deflation.
"Expectations of Renzi delivering are building day by day. It raises the question whether he can live up to the hopes and if there's risk of profit-taking in the near term," said Commerzbank strategist Michael Leister.
"It seems like sentiment and the downward momentum in peripheral yields is very strong. I wouldn't recommend to catch the falling knife. I see another five to 10 basis points (fall in Italian yields) near-term."