S&P lowered its long-term sovereign credit ratings to 'BBB' from 'BBB+' on Tuesday. The new rating remains investment grade and is two notches above "junk" status. The firm offered a negative outlook, saying it could make another downgrade in 2013 or 2014.
Lower credit ratings can make it more expensive for the government to borrow money and can spook bond investors.
S&P says Italy's economic output is falling and its economic prospects are getting worse after a decade of weakness. It now expects Italy's GDP to fall by 1.9 per cent this year, worse than the 1.4 per cent decline it forecast in March.
S&P said Italy has run budget surpluses for most of the last decade, but taxes on capital and labour are higher than tax levels on property and consumption and Italian labour has become expensive compared with other EU countries.
S&P said those problems are hurting the country's growth and economic competitiveness.
Italy has the Eurozone's third-largest economy after Germany and France, and it is saddled with a huge debt. Its debt is equal to about 127 per cent of its annual economic output, a proportion second only to Greece. Italy was able to manage its debt while its economy was growing, but a leading international economic body forecasts Italy's economy will shrink by 1.5 per cent this year and grow only 0.5 per cent in 2014, meaning its debt will become an even bigger part of annual GDP.
Last week, the International Monetary Fund pressed Italy to do more about "unacceptably high" unemployment, especially among young people and women, and urged it to bring back an unpopular property tax whose return could threaten the survival of Premier Enrico Letta's coalition government. The tax raises about 4 billion in euros every year and the European Union says Italy needs to make up for the shortfall if the tax is eliminated.
The European Central Bank has cut the rate it charges private-sector banks to a record low and for three years it has given unlimited cheap loans to banks. It also offered to intervene in bond markets and buy the debt of financially troubled countries that promise to reform their finances. The proposed offer has supported bond prices and lowered interest yields, taking pressure off the government finances of Italy and Spain and relaxing the atmosphere of crisis that hit Europe in 2012.
But the low interest rates and cheap loans have not pulled the eurozone out of its recession. Some banks have strained finances, so their low rates are not always being passed onto businesses.Suggest a correction