Moody's surprised markets by downgrading Italy's government bond rating by two notches to Baa2 and warned it could cut it further, piling on pressure just hours before the euro zone third-largest economy launches its latest bond sale.
The ratings agency blamed increased liquidity risks for the country amid persistent euro zone woes and an expected deterioration of Italy's already weak economic condition as the main reasons behind its decision.
The downgrade of Italy to just two notches above junk status could raise already-painful borrowing costs for the country and risks undermining Prime Minister Mario Monti's efforts to turn market sentiment through tough fiscal and structural reforms.
The stark warning from Moody's, which comes as investors are already fretting about Spain's ability to mend its banking sector, knocked the euro down about a quarter of a cent and sunk BTP futures 60 ticks down.
"Italy's government debt rating could be downgraded further in the event there is additional material deterioration in the country's economic prospects or difficulties in implementing reform," the agency warned.
"Should Italy's access to public debt markets become more constrained and the country were to require external assistance, then Italy's sovereign rating could transition to substantially lower rating levels."
Moody's took its ratings for Italy below those from agencies Standard & Poor's Ratings Services and Fitch Ratings, a move that risks triggering further investment outflows from Italy.
In an interview published on Friday, Peter Bofinger, an economic adviser to German Chancellor Angela Merkel, praised Monti's reform efforts and said Italy's borrowing costs of 6.0-6.5 per cent were 'unreasonably high' in view of its structural balance and low deficit.
"It takes time to lower the debt. The key thing now is the deficit," Bofinger said.
City A.M. Reporter