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 percent this year, worse than the 1.4 percent decline it forecast in March.
S&P said Italy has run budget surpluses for most of the last decade, but taxes on capital and labor are higher than tax levels on property and consumption and Italian labor 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 percent 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 percent this year and grow only 0.5 percent 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.
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