Italy’s credit rating was cut by Standard & Poor’s on concern that weakening economic growth and a “fragile” government mean the nation won’t be able to reduce the euro-region’s second-largest debt burden.

The rating was lowered to A from A+, with a negative outlook, S&P said in a statement. S&P said Italy’s net general government debt is the highest among A-rated sovereigns, and the company now expects it to peak later and at a higher level than it previously anticipated.

The decision sent the euro sliding for a third day against the dollar as investor concern rose that European policy makers will fail to contain the debt crisis. Greece’s government plans another call with its main creditors today as it seeks to stave off default, while U.S. Treasury Timothy F. Geithner urged the region to adopt additional tools.

“It’s a reminder that we’ve had the market in control but policy makers have been slow to think in any forward-looking context,” said Adrian Foster, head of financial-market research for Asia at Rabobank Groep NV in Hong Kong. “Policy makers across the euro zone have been well and truly asleep at the wheel for quite a while now and are only taking measures when the market pushes them to it.”

Euro Falls

The euro fell 0.5 percent to $1.3614 at 12:29 p.m. in Tokyo. Stocks also retreated, with the MSCI Asia Pacific index down 1.1 percent, and futures on the U.S. S&P 500 index losing 0.9 percent.

S&P said it lowered its outlook for Italy’s growth to a 0.7 percent annual average for 2011 to 2014, from a prior projection of 1.3 percent. “We believe the reduced pace of Italy’s economic activity to date will make the government’s revised fiscal targets difficult to achieve,” it said.

Italy follows Spain, Ireland, Portugal, Cyprus and Greece as euro-region countries having their credit rating cut this year. Prime Minister Silvio Berlusconi passed a 54 billion-euro ($73 billion) austerity package this month that convinced the European Central Bank to buy its bonds after borrowing costs surged to euro-era records in August. The plan to balance the budget in 2013 wasn’t enough to sway S&P.

“We expect that Italy’s fragile governing coalition and policy differences within parliament will continue to limit the government’s ability to respond decisively to domestic and external macroeconomic challenges,” S&P said.

U.S. Rating

The decision comes just weeks after S&P stripped the U.S. of its AAA credit rating for the first time. While the Aug. 5 move roiled global markets, bond investors ignored S&P’s warnings about U.S. creditworthiness and piled into Treasuries. The yield on the benchmark U.S. government bond fell to a record 1.8770 on Sept. 12.

“This Italian downgrade is quite unexpected and I think it stinks,” said Luca Silipo, chief Asia-Pacific economist in Hong Kong at Natixis SA, who previously worked at Italy’s central bank. Italy adopted budget-tightening measures in part because of pressure from ratings companies, and is now getting punished because growth prospects are deemed to be dented by the austerity package, he said in a Bloomberg Television interview.

Political Calculus

Italy’s downgrade may aggravate political volatility -- Berlusconi faces four trials -- after a decade with virtually no economic growth that has undermined debt reduction. Its government debt was 119 percent of gross domestic product last year, more than any euro country after Greece.

Unlike Ireland and Portugal, which followed Greece in seeking bailouts from the European Union and the International Monetary Fund, Italy until July had managed to skirt the worst of the fallout from the debt crisis.

While its budget gap was 4.6 percent of GDP in 2010, lower than France and Germany, debt will reach 120 percent this year.

Italy’s economy expanded an average 0.2 percent annually from 2001 to 2010, compared with 1.1 percent in the euro area. GDP rose 0.3 percent in the second quarter from the three months through March, when it grew 0.1 percent, the national statistics institute said on Sept. 9.

With austerity in the pipeline, “we now expect the economy to contract in 2012 and 2013,” Ben May, an economist at Capital Economics Ltd. in London, said in a Sept. 9 note.

Deficit Reduction

Berlusconi pushed through two packages of deficit cuts since mid-July totaling about 100 billion euros. Measures included raising the value-added tax by one percentage point to 21 percent and a levy on incomes of more than 300,000 euros to balance the budget by 2013. The second, announced on Aug. 5, was a condition of ECB support.

While ECB purchases knocked more than 100 basis points off the yield in a week, borrowing costs began rising again as the government diluted the package. That prompted Berlusconi to revise the plan, introducing the increase in the value-added tax, raising the levy on high earners and lifting the retirement age for women.

The yield on 10-year notes was at 5.6 percent yesterday, pushing the difference investors demand to hold Italian bonds instead of benchmark German bunds to 379 basis points. The cost of insuring Italian debt against default was 488 basis points compared with 240 on Dec. 31, 2010.

One strength for Italy is that household and corporate balance sheets are “relatively strong,” which should let the government tap local savings and allow a more gradual fiscal adjustment than possible for some other southern European nations, S&P said.

Time to Buy

“Italy may be cheaper in the bond market in the month ahead, but it seems like a good -- on balance -- trade to be accumulating Italian bonds in coming months and quarters,” George Boubouras, head of investment strategy at UBS AG’s Australian wealth-management unit, said in a Bloomberg Television interview. “A default scenario for such a large economy just seems inconceivable.”

S&P in May and Moody’s Investors Service in June first warned that they may downgrade Italy, saying the government may miss its revenue and deficit targets amid chronically sluggish growth and possible political instability.

The government’s first budget package approved in May wasn’t enough to convince S&P that Italy will be able to reduce its debt. The rating company said on July 1 that even with the budget cuts, there’s a “one-in-three likelihood that the ratings could be lowered within the next” two years because anemic economic growth would undermine fiscal goals.

Greek Calls

Meantime, Greek Finance Minister Evangelos Venizelos held “substantive” discussions with European Union and International Monetary Fund officials about securing a sixth installment of rescue funds, the Athens-based finance ministry said in an e-mailed statement after a teleconference last night. A second call will be held tonight.

Geithner said that new crisis-fighting measures may eventually be agreed even after some European officials poured cold water on his proposals at a summit in Poland at the weekend.

“I think you’re going to see them draw on the lessons of our crisis, draw on the lessons of things that worked here in the United States,” Geithner said in a Bloomberg Television interview yesterday in Washington. “I think you’ll see that reflected in some of the choices they make.”

Bloomberg