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Italy yields hit 8-year low as markets give Renzi the floor

* Markets give Italy's Renzi the benefit of the doubt

* Renzi expects cabinet to be in place by Monday

* Some investors remain sceptical of Renzi impact

LONDON, Feb 19 (Reuters) - Italian borrowing costs hit eight-year lows on Wednesday as Prime Minister-designate Matteo Renzi completed talks on forming a cabinet 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 failing 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 national output.

Renzi, who expects to have his cabinet in place by Monday, 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 2 basis points up on the day at 3.59 percent.

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 accelerated 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 bps, less than half its crisis peaks. Knight expects a further 20 bps fall in the premium in the coming month.

Milan's FTSE MIB index fell 0.2 percent, underperforming other European stock markets, but remained close to levels last seen in mid-2011.

"IT'S MORE ABOUT THE EURO ZONE"

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 reforms. Some investors are unconvinced he will significantly change Italy.

For Christoph Kind, head of asset allocation at Frankfurt Trust, the change in leadership means nothing more than political instability. However, an improving outlook for the euro zone as a whole was reassuring.

"We try to be as overweight as we can on Italy. From an investor's point of view, it's more about the euro zone crisis (abating) than about politics," he said. "It looks like political instability to us, but the market reaction was outright positive so we are comfortable with our position."

Sanjay Joshi, head of fixed income at London and Capital, has been "relatively positive on Italy recently".

"But that has less to do with what's going on in Italy and more with what's going on in the euro zone as a whole and with the ECB (European Central Bank) outlook," he said.

Expectations of further ECB monetary policy easing later this year, driven by low inflation, have prompted investors to search for higher yields in riskier bonds, including Italy's.