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Italy downgrade adds to eurozone contagion fears

Standard and Poor’s drops credit rating to A from A+, blaming sluggish economy and ineffective government reforms

Italy has had its sovereign credit rating cut by Standard and Poor’s , with the ratings agency keeping the country’s outlook on negative in a major surprise that adds to contagion fears in the debt-stressed eurozone.

The agency cut Italy’s government debt rating to A from A+ and said Italy’s economic growth prospects were getting weaker, with planned reforms by the government not expected to help much.

“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 said in a statement.

Italy follows eurozone partners Spain, Ireland, Greece, Portugal and Cyprus in having its credit rating downgraded this year.

Kathy Lien, director of currency research at GFT, said the ratings downgrade would impact heavily on the eurozone. “This is definitely going to put a damper on any recovery in euro/dollar. Italy is a much bigger deal than Greece,” she said. “It’s a much bigger deal because a lot more countries are exposed to Italian debt than they are Greek debt. The greatest concern was never really about Greece but the contagion over to Italy and to Spain.”

US stocks fell ahead of S&P’s announcement but staged a late comeback as fears of a near-term Greek debt default faded on news of a possible deal to advance new bailout funds to Athens.

The Nikkei average is expected to slip on Tuesday, though it is likely to stick to a narrow range ahead of a US Federal Reserve meeting.

“Japanese markets were closed on Monday for a national holiday, meaning investors here have to catch up to all of the developments overseas,” said Kenichi Hirano, operating officer at Tachibana Securities.

“Worries about Europe remain but investors are unlikely to take aggressive new positions ahead of the Fed meeting, which will keep the Nikkei trading in a range.”

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