Italy credit rating slashed by Moody's from Aa2 to A2

The Italian Prime Minister said he had been expecting the announcement from Moody's

The Italian government's credit rating has been slashed by Moody's from Aa2 to A2 with a negative outlook.

The ratings agency blamed a "material increase in long-term funding risks for the euro area", due to lost confidence in eurozone government debts.

Despite Rome's low current borrowing needs, and low private-sector debt levels in Italy, Moody's said market sentiment had turned against the euro.

Prime Minister Silvio Berlusconi said the decision was expected.

"The Italian government is working with the maximum commitment to achieve its budget objectives," said Mr Berlusconi.

He said that a plan to balance the government's budget by 2013 had been approved by the European Commission.

Sell-off

The initial market reaction to the downgrade was muted.

The news broke half an hour after the close of trading on the New York Stock Exchange.

But after-hours trading in stock market futures suggested that at least one percentage point of a late 4% market rally may have been wiped off.

The euro meanwhile immediately dropped 0.5% against the dollar on the news.
Analysts say the downgrade is likely to be followed by similar cuts in the credit rating of Italy's banks, which would put severe pressure on their ability to borrow.

"This downgrade will make it even harder for Italy to borrow," says BBC business editor Robert Peston. "However, that is not the worst of it.

"If Italy is looking like a more risky place to lend, its banks... will find it harder and more expensive to borrow. The [eurozone] banking crisis will be exacerbated."

Slow response
The rationale for Moody's downgrade will also be worrying for other eurozone governments, such as Spain, whose borrowing costs have also risen like Italy's as markets have lost confidence in their creditworthiness.

Moody's also raised warnings about Italy's growth outlook, citing structural economic problems in Italy, as well as the global economic slowdown.

Another problem noted by the rating agency was what it called political and economic "implementation risks".

"The question is, if [eurozone governments] will move fast enough... to really put in place a credible solution," says Robert Peston.
An expansion of the eurozone's bailout fund already approved by the euro's 17 governments in July - which is now seen by markets as inadequate - has still yet to be ratified by all the national parliaments.

The slow political response to the emerging crisis, necessitated by the European Union's institutional set-up, has been criticised by many commentators, including European Commission President Jose Manuel Barroso.

In hock
However the key issue for Moody's was the change in the market's attitude towards eurozone government debts.

The Italian government has for several years earned more in tax revenues than it spends. However, the government also has a large outstanding debt - equivalent to nearly 120% of GDP.

The government relies heavily on the markets' willingness to relend these debts as they come due, and to lend it the cost of meeting its interest payments.

Moody's said that Italy could be further downgraded to "substantially lower rating levels" if a further deterioration in investor sentiment made it even harder for the country to raise cash from the markets.

Italy's cost of borrowing rose sharply over the summer on market fears that a slowdown in Italian growth could make existing debts unsustainable.

That prompted the European Central Bank to intervene by buying up Italy's debts - a controversial policy in Germany. But despite the ECB's action, Italian borrowing costs have begun to creep up again in recent weeks.