ROME (Reuters) - Canadian rating agency DBRS on Friday cut Italy's sovereign credit rating to BBB (high) from A (low), a move that could raise borrowing costs for struggling Italian banks.
DBRS, previously the only major agency with a rating in the A band for Italy, said its decision reflected uncertainty over the country's ability to pass reforms, continuing weakness in the banking system, and fragile growth.
It attached a stable trend to its new BBB (high) rating.
The downgrade will mean Italy's banks will have to pay more to borrow money from the European Central Bank when they use the country's sovereign bonds as collateral. It may also make Italian debt less attractive for foreign buyers.
Of the four agencies used by the ECB to determine collateral requirements, DBRS was the only one that gave Italy an A-band rating. This allowed its beleaguered lenders to continue to receive cheap funding.
Standard & Poor's rates Italy BBB-, Moody's rates it BBB+ and Fitch rates it Baa2.
An Italian Treasury source, who asked not to be named, played down the repercussions of DBRS's move, saying it may have some impact on the yields of short-term debt, but "will have no significant effect on our debt servicing costs."
Italy's public debt, at around 133 percent of national output, is the highest in the euro zone after Greece's.
DBRS put Italy's rating under review with negative implications in August, citing political uncertainty around a referendum held in December, pressure on banks, economic weakness and a less stable external environment.
The referendum on constitutional changes brought a stinging defeat for then-prime minister Matteo Renzi, prompting him to step down. He was replaced by former foreign minister Paolo Gentiloni.
After the vote, DBRS said the outcome was "credit negative", but since then Gentiloni has set aside 20 billion euros ($21.26 billion) to support banks in difficulty. About a third will be used to try to save Monte Dei Paschi di Siena, the country's fourth-largest bank, which desperately needs fresh capital.
"The new interim government may have less room to pass additional measures, limiting the upside for economic prospects," DBRS said in its statement on Friday.
"Moreover, despite recent plans for banking support, the level of non-performing loans (NPLs) remains very high, affecting the banking sector’s ability to act as a financial intermediary to support the economy."
The referendum outcome did not trigger much political instability, with Gentiloni quickly installed at the head of a cabinet almost identical to Renzi's, and economic data and borrowing costs have also been little changed since the vote.
editing by Richard Lough, Larry King