It will get worse before it gets better.

The Italian government's credit rating has been slashed by Moody's from Aa2 to A2 with a negative outlook.

The ratings agency blamed a "material increase in long-term funding risks for the euro area", due to lost confidence in eurozone government debts.

Despite Rome's low current borrowing needs, and low private-sector debt levels in Italy, Moody's said market sentiment had turned against the euro.

Prime Minister Silvio Berlusconi said the decision was expected.

"The Italian government is working with the maximum commitment to achieve its budget objectives," said Mr Berlusconi.

He said that a plan to balance the government's budget by 2013 had been approved by the European Commission.


The initial market reaction to the downgrade was muted.

The news broke half an hour after the close of trading on the New York Stock Exchange.

But after-hours trading in stock market futures suggested that at least one percentage point of a late 4% market rally may have been wiped off.

The euro meanwhile immediately dropped 0.5% against the dollar on the news.