By Simon Miller

Moody's has downgraded Italy to just two notches above junk status as the knock-on effects of Spain and Greece continue.

The ratings agency downgraded Italy's debt from A3 to Baa2 with a negative outlook due to the threat of increased funding pressures.

In a note, Moody's said that the country was likely to experience a "further sharp increase in its funding costs or the loss of market access...due to increasingly fragile market confidence, contagion risk emanating from Greece and Spain and signs of an eroding non-domestic investor base".

It continued: "The risk of a Greek exit from the euro has risen, the Spanish banking system will experience greater credit losses than anticipated, and Spain's own funding challenges are greater than previously recognised."

In addition, Moody's said Italy's own near-term economic outlook had deteriorated "as manifest in both weaker growth and higher unemployment, which creates risk of failure to meet fiscal consolidation targets".

The ratings agency added: "Failure to meet fiscal targets in turn could weaken market confidence further, raising the risk of a sudden stop in market funding."

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