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* EU leaders choose France's Lagarde as next ECB chief
* Euro zone bond yields hit record lows
* Stock markets rally on news
* Investors relieved ECB will not be led by policy hawk
* Lagarde expected to continue Draghi's dovish stance (Adds Italian bond landmarks, updates prices)
By Dhara Ranasinghe
LONDON, July 3 (Reuters) - European markets surged on Wednesday as investors bet that France's Christine Lagarde would double-down on the European Central Bank's dovish monetary easing stance as the bank's next chief.
Government borrowing costs across the single-currency bloc tumbled to record lows and euro zone blue-chip stocks hit their highest in more than a year after EU leaders agreed late on Tuesday to name Lagarde as the ECB's new head.
A shrewd negotiator who has run the IMF but has little monetary policy experience, Lagarde would face the challenge as the ECB's new chief of having to revive the euro zone economy with a nearly depleted policy arsenal.
For now, investors focused on two positive factors.
One, that a monetary policy hawk such as Germany's Jens Weidmann would not be taking over from Italy's Mario Draghi at the ECB from November.
Two, the likelihood that Lagarde was unlikely to alter the ECB's current dovish policy stance, judging by recent comments.
"Crucially, Lagarde has always been supportive of the ECB's unconventional policies, including QE (quantitative easing), which is essential for the credibility of future decisions," said Pictet Wealth Management strategist Frederik Ducrozet.
"She could very well be the one implementing a QE2 programme in her first year as president."
Like other major central banks, the ECB has done an about-turn on its policy stance this year, saying it stands ready to ease policy again if inflation remains weak.
Euro zone money markets anticipate a 10 basis point cut in the ECB's deposit rate in September and expectations for another round of asset purchases are building.
Most 10-year euro zone bond yields slid to fresh record lows on Wednesday as investors bet the ECB's dovish stance would continue under Lagarde.
Belgium's 10-year bond yield turned negative for the first time. Benchmark German Bund yields fell to minus 0.399% - flirting with the ECB's minus 0.40 deposit rate in a further sign that markets are braced for further rate cuts.
The euro held steady at $1.1284 and euro zone stocks rose to their highest in over a year.
Andrew Kenningham, chief Europe economist at Capital Economics, which expects the ECB to cut rates in September and relaunch asset purchases before year-end, said the risk to that forecast was the possibility of a hawk succeeding Draghi.
"So it follows that the key thing about the appointment of Christine Lagarde as the next head of the ECB is that she is not Jens Weidmann," he said.
In Italy, viewed as a key beneficiary of new ECB QE, 10-year bond yields slid 22 bps to 1.63%, its lowest level since October 2016. Two-year yields have turned negative for the first time in over a year.
The closely watched Italy/Germany 10-year bond yield spread was closing in on 200 basis points for the first time in over a year.
In another positive development for Italy, the European Commission dropped its threat of disciplinary action against Italy on Wednesday after Rome took action to bring its growing debt into line with the bloc's fiscal rules.
But with more than half of the euro zone's government bond market trading with negative yields, the impact of further easing steps is expected to be limited.
That creates a challenging environment for Lagarde, who will take over at a time when the global economy is grappling with a bitter trade war, the risk of a hard Brexit and weak inflation.
Lagarde's immediate challenge at the ECB would be to overcome her shortcomings in monetary policymaking just as other key ECB posts have recently changed hands -- Philip Lane has just taken over as ECB chief economist and Luis de Guindos became ECB vice president last year.
Her communication skills will also be under scrutiny, especially coming after Draghi, who has been highly regarded for his skilful communication with markets in set-piece speeches and in regular post-meeting press conferences.
Lagarde, a former antitrust lawyer with Baker McKenzie, became French finance minister in 2007 and then took over at the IMF. A non-economist leading a major central bank is unusual, although U.S. Federal Reserve chairman Jay Powell is also a trained lawyer.
"If confirmed, Lagarde would be the first ECB president ever without any experience in monetary policy," said Mark Haefele, chief investment officer at UBS Global Wealth Management.
"Lagarde will likely face many challenges along the way. While the IMF chief is considered a qualified candidate, that won't necessarily make Europe a more attractive place to invest over a tactical horizon," he said.
For others, Lagarde's political skills mean that as ECB chief, she should could hold greater sway in encouraging the bloc to support growth with more fiscal stimulus.
"The job of the ECB presidency is 50% economics and 50%politics so given her background at the IMF and French finance ministry she is well versed with the personalities in Europe and the world," said Peter Kinsella, head of FX strategy at UBP in London. "The fundamental problem in Europe is that we will require greater coordination between fiscal and monetary policy and Lagarde will be able to do that."
(Reporting by Dhara Ranasinghe; Additional reporting by Virginia Furness and Sujata Rao in London and Balazs Koranyi in Frankfurt; graphics by Virginia Furness and Ritvik Carvalho; Editing by Mike Dolan and Gareth Jones)