Italy has had its credit rating downgraded by ratings agency Moody's from Aa2 to A2, with a negative outlook.
"The negative outlook reflects ongoing economic and financial risks in Italy and in the euro area," the agency said in a statement on Tuesday.
"The size of the rating action is largely driven by the sustained increase in the country's susceptibility to financial shocks due to a structural shift in market sentiment regarding euro-area countries with high debt burdens"
The move threatens to further increase to cost of borrowing for Italy's government and banks.
It follows a similar downgrade by another ratings agency, Standard & Poor's, last month.
Italian prime minister Silvio Berlusconi said the decision was not a surprise and insisted the government would be able to handle its economic woes.
"The Italian government is working with the maximum commitment to achieve its budget objectives," he said.
Italy gave the go ahead for a €54bn austerity plan last month designed to balance its budget by 2013.
The move came as European Union finance ministers met in Luxembourg to discuss how to tackle the eurozone crisis.
Following the meeting chancellor George Osborne said his European colleagues had taken "some steps forward".
"I think everyone now is aware of the gravity of the situation in the eurozone," he told Sky News.
"I am confident that we are moving forward and for the UK chancellor, not being in the euro, I am more and more convinced that the biggest single boost you could make to the UK economy this autumn would be a resolution of the eurozone crisis."