Business News : S&P adds to euro stress with Italy cut

ROME (Reuters) - Standard and Poor's rocked the euro and bond markets on Tuesday with a one-notch cut in Italy's credit rating that judged it less creditable than Slovakia and added to pressure on a debt-stressed euro zone.

S&P's cut its ratings on the euro zone's third largest economy to A/A-1 from A+/A-1+ and kept its outlook on negative, warning of a deteriorating growth outlook and damaging political uncertainty.


The euro fell more than half a cent against the dollar in response.


The agency, which put Italy on review for downgrade in May, said that the outlook for growth was worsening and there was little sign that Prime Minister Silvio Berlusconi's fractious center-right government could respond effectively.


Under mounting pressure to cut its 1.9 trillion euro debt pile -- 120 percent of gross domestic product -- the government pushed a 59.8 billion euro austerity plan through parliament last week, pledging to balance its budget by 2013.


But there has been little confidence that the much-revised package of t ax hikes and spending cuts, agreed only after repeated chopping and changing, will do anything to address Italy's underlying problem of persistent stagnant growth.


"We believe the reduced pace of Italy's economic activity to date will make the government's revised fiscal targets difficult to achieve," S&P's said in a statement.


"Furthermore, what we view as the Italian government's tentative policy response to recent market pressures suggests continuing future political uncertainty about the means of addressing Italy's economic challenges," it said.


Berlusconi's coalition has been plagued by infighting and policy disagreements and the prime minister himself has been battling a widening prostitution scandal which has distracted the government and badly damaged his personal credibility.


In a statement on Tuesday, Berlusconi sai d the S&P move seemed fueled by media stories and said his government was preparing measures to boost growth in Italy, which has been the euro zone's most sluggish economy for more than a decade.


"The assessments by Standard & Poor's seem dictated more by newspaper stories than by reality and appear to be negatively influenced by political considerations," he said, adding that his center-right coalition had repeatedly shown it had a secure parliamentary majority.


S&P said budgetary savings may not be possible because the government is relying heavily on revenue increases in a country that already has a high tax burden and is facing weakening economic growth prospects. In addition, market interest rates are expected to rise, it said.


Italian sources said on Monday the government was preparing to cut its growth forecast to 0.7 percent in 2011 from a pre vious 1.1 percent and for 2012 to "1 percent or below."


RATINGS DICTATORSHIP


S&P's move drew a mixed response from Italy's European partners with Peter Altmaier, a senior parliamentarian in Chancellor Angela Merkel's center-right coalition saying it demonstrated the need for governments to show responsibility.


French Foreign Minister Alain Juppe was more critical. Noting that Italy had already implemented a number of budget measures, he attacked the decision.


"We should not cave in under this dictatorship of ratings agencies, whose transparency is in serious need of improvement," he told Europe 1 radio.


Financial markets had been expecting rival agency Moody's to move first, after it put Italy on review in June and said last week it would decide within a month whether to cut its rating. Moody's declined to comment on Tuesday.


S&P's rating is now three notches below Moody's and puts Italy below Slovakia and level with Malta.

"The rating downgrade was not totally unexpected, even though it came from the agency we didn't expect," said Paola Biraschi, banking analyst at RBS in London.


"To me it seems like a competition between rating agencies to publish the downgrade first," she said.

Italy's stock market weakened initially but turned positive with other European markets in early trade, as some dealers said markets had already priced in a downgrade.


Italian 10-year government bond yields jumped by as much as 14 basis points before recovering to trade around 5.6 percent. Spreads over German bunds widened to more than 386 basis points.


Only the European Central Bank, which has been buying Italian bonds to prop up the market, has kept Rome's borrowing costs from spiraling out of control, but yields have crept back up steadily since the ECB stepped into the market in August.


"Italy is now struck in a self-fulfilling downward spiral from which it is unlikely to be able to extract itself without external help," said Sony Kapoor, of Brussels-based think tank Re-Define.


"Without full confidence in the credit-worthiness of Italy, it's impossible to have full confidence in the solvency of the European banking system," he said.