S&P cuts Italy's rating to just above junk in blow to PM Renzi

By Gavin Jones

ROME (Reuters) - Standard & Poor's cut Italy's sovereign credit rating on Friday from BBB to BBB-, just one notch above junk, saying weak growth and poor competitiveness undermined the sustainability of its huge public debt.

The downgrade is a blow for Prime Minister Matteo Renzi, who came to office in February pledging an ambitious reform agenda to lift Italy out of recession, but has seen the economy continue to shrink.

S&P said the new BBB- rating carried a stable outlook. It forecast Italian economic growth would be just 0.2 percent in 2015 and would average 0.5 percent in 2014-2017.

As recently as June, the agency had confirmed Italy's BBB rating and forecast average growth of 1.0 percent over the three-year period.

Italy's economy is expected to shrink in 2014 for the third straight year.

Several analysts said they were surprised by S&P's decision, noting Italy's borrowing costs are now at record lows due to expectations of monetary easing by the European Central Bank.

The Italian Treasury declined to comment.

S&P projected Italy's debt, which at 132 percent of gross domestic product is proportionately the highest in the euro zone after Greece, would hit 2.256 trillion euros ($2.77 trillion) by end-2017, 80 billion higher than it forecast in June.

"Such a large increase in debt, combined with consistently low growth and eroded competitiveness, are not commensurate with a 'BBB' rating," it said.

Prospects for cutting the debt have also been weakened by the steady decline in inflation, S&P said. This makes it harder to pay back the interest on fixed rate bonds and lowers nominal GDP.

Analysts said S&P's move piled pressure on the ECB to inject money into the euro zone economy by buying government bonds.

"There are no structural reforms that can bring growth quickly. With inflation so low and EU budget constraints, the ECB has to intervene," said Raffaella Tenconi of Bank of America Merrill Lynch.

Italy's woes were underscored by the fact that on Friday S&P raised to A the credit rating of Ireland, which was even more deeply embroiled in the euro zone debt crisis, praising its solid growth and convincing debt reduction path.

Moody's rates Italy Baa2, while Fitch rates it 'BBB-plus'. Both have a stable outlook.

(1 US dollar = 0.8137 euro)

(Reporting By Gavin Jones and Valentina Za; editing by Steve Scherer and Mark Trevelyan)