MOODY’S Investors Service cut Italy’s government-bond rating to just two notches above junk territory Friday and warned of the possibility of further action, highlighting the challenges the sovereign and the wider region face in escaping the ongoing debt crisis.

    The credit-ratings firm lowered Italy’s bond rating to Baa2 from A3, and maintained a negative outlook, saying the country faces a greater likelihood of a further sharp increase in funding costs or loss of market access given euro zone risks. It also noted that economic conditions have continued to deteriorate.

    The move by Moody’s is the latest illustration of the rapid descent in creditworthiness of euro zone sovereigns and their banks, as the debt crisis drags on the health of the currency bloc as a whole. In January, Standard & Poor’s Ratings Services cut Italy’s rating by two notches to triple-B-plus, while stripping Austria and France of their triple-A ratings -- but sparing Germany -- and downgrading six others.

    In May, Moody’s docked the credit ratings of 26 Italian lenders, citing their vulnerability to mounting loan defaults and potential funding problems.

    The euro briefly weakened on Friday’s announcement, slipping to US$1.2185 from US$1.2206 but staying above Thursday’s two-year low of US$1.2166.

    Japan’s Finance Minister Jun Azumi declined comment on Italy’s downgrade but expressed confidence in Europe’s ability to carry out ambitious steps such as establishing a common banking sector supervisor and forging closer unity on fiscal policy.

    Moody’s said Friday that Italy is susceptible to increasingly fragile market confidence, contagion risk from Greece and Spain and signs of an eroding nondomestic investor base.

    The firm noted that events in Greece have deteriorated materially since the beginning of the year, while the possibility of a Greek exit from the euro zone has increased.

    Additionally, Moody’s said there is increased likelihood that Spain may require further external support and the country’s banking system will experience greater credit losses than anticipated.

    Given this environment, Moody’s said Italy’s high debt levels, significant annual funding needs in 2012 to 2013 and diminished overseas investor base have generated increasing liquidity risk.

    Moody’s now expects Italy’s real gross domestic product growth to contract by 2 percent this year, further pressuring its ability to meet fiscal targets.

    (SD-Agencies)