European shares rally as FTSE starts 2017 by setting record high

* STOXX 600 closes 0.7 percent higher

* Britain's FTSE 100 hits record high

* Banks, commodities-linked firms lead (Adds details and quote, updates prices)

By Kit Rees and Atul Prakash

LONDON, Jan 3 (Reuters) - Strength in financials and commodity-related stocks continued to underpin European equity markets on Tuesday, with Britain's blue-chip index starting the new year at a record high and other major indexes hitting fresh peaks.

The pan-European STOXX 600 closed 0.7 percent higher after hitting its highest level since December 2015. Britain's FTSE 100, shut on Monday for a holiday, closed 0.5 percent higher at 7,177.89 points, a record closing high, after a fresh all-time peak of 7,205.45 earlier in the day.

"We've been particularly bullish on the FTSE whilst a lot of people were going short," said John Moore, trader at Berkeley Capital. "It's just good news all round - gold's up, we've had a bit of a bounce-back in oil as well ... propping up the European market, so we've been buying into this in the last week or so. We expect the trend to continue."

Europe's basic resources sector and oil & gas were up 1.3 percent and 0.9 percent respectively, buoyed by stronger commodity prices.

Financials were stand-out winners, with the STOXX Europe 600 Banks index finishing 2.8 percent higher after hitting a one-year high.

Banks were in demand as concerns of a tighter regulatory environment were pushed back. Global banking regulators postponed the approval of long-awaited rules designed to avert a repeat of the financial crisis after failing to agree on the minimum amount of capital banks must hold.

Italian banks were once again among top risers, with newly merged Banco BPM gaining 7.2 percent on its second day of trading, building on a strong rise in the previous session.

The Italian banking index, which slumped more than 38 percent in 2016 on worries about bad loans, closed 2.1 percent higher after hitting its highest level since May 2016.

Fellow banks Credit Suisse and Bank of Ireland were also among top STOXX gainers, with their shares rising 6.4 percent and 6.8 percent respectively.

Among other sharp movers, Euronext surged nearly 7 percent after London Stock Exchange Group agreed to sell its French clearing business to Euronext for 510 million euros ($534 million) in its bid to win regulatory approval for a merger with Deutsche Boerse.

InterContinental Hotels Group hit a record high then closed up 1.3 percent, boosted by an upgrade to "overweight" from "equal-weight" from Barclays.

Barclays analysts said that they expected IHG's results in February to be a positive catalyst for the stock, and saw a benefit from the firm's exposure to the United States.

However, a downgrade weighed on British retailer Next , which fell 4.3 percent.

Deutsche Bank cut its rating on the stock to "hold" from "buy", citing a more challenging year for European general retailers in 2017, especially in the UK, where they expect inflation to lead to a softening in demand.

(Additional reporting by Atul Prakash; Editing by Vikram Subhedar and Dominic Evans)