The New York-based agency cut its rating on Italy's debt to "BBB-." That's its lowest investment-grade rating and one notch above "junk" status.
S&P said it expects that the Italian economy will emerge from recession early next year. But the agency now predicts Italy's economy will grow only 0.2 per cent in 2015, down from its previous forecast of 1.1 per cent for the year.
Italy's weak economy and the country's eroding competitiveness are undermining its ability to sustain its public debt, S&P said in a note outlining its reasons for the downgrade.
"Our forecast also reflects our view of Italy's weak domestic fundamentals, including its difficult business environment and competitiveness challenges," the agency said.
Italy's economy has been struggling amid a broad economic slump in Europe, weighed by record-high unemployment and growing government debt. The economy contracted 0.1 per cent in the third quarter, bucking a mild European Union trend of growth seen even in economically battered Greece.
Looking further out, S&P predicts Italy's economy will grow between 0.5 per cent and 1.2 per cent from 2014 through 2017. That's slower than Italian government forecasts ranging from 0.7 per cent to 1.9 per cent growth in the same period.
One key impediment to growth is Italy's unemployment rate, which is above 12 per cent. That's helped constrain private-sector spending and contributed to subdued investment activity — trends S&P anticipates will continue.
Italy's prime minister, Matteo Renzi, is pushing legislation to make it easier to fire workers and reduce employers' incentive to hire temporary workers. The plan, dubbed the Jobs Act, is meant to help encourage business to hire at a time when youth unemployment in Italy skyrocketed to 43.3 per cent as of October.
The proposed legislation is opposed by labour unions, some of which have staged protest marches and called for a nationwide strike. Should it become law, S&P believes it could help stem job losses in the near-term and eventually help add jobs.
"Although we think the announced reform measures in a wide range of policy areas will ultimately help strengthen the economic fundamentals and resilience of the Italian economy, these benefits will likely not be felt in the near term," S&P said. "In fact, the persistently weak economic conditions could raise fiscal risks before the growth-enhancing structural reforms take root."Suggest a correction