Europe News

Why Italy and investors are brushing off downgrade

Italy has rejected Standard and Poor's (S&P) downgrade of the country's sovereign credit rating to just above junk level, saying the government doesn't share the same concerns as the international credit rating agency.

Economy Minister Pier Carlo Padoan said the country's reform program was getting positive feedback, in the interview with German newspaper Die Welt, according to Dow Jones. But he added that there "continue to be certain concerns how fast this will produce the expected results".

"We are very determined to continue our (reform) program, which the approval of labor market reform clearly shows, and therefore we don't share such concerns," Padoan said, adding that criticism over the speed of Italy's reforms "isn't justified anymore".

Certain changes, he said, such as reform of the labor markets and of the tax system, had already come into effect and more reforms were on the way.

Rome, Italy
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It comes after S&P cut Italy's sovereign credit rating from BBB to BBB-, one notch above junk, on Friday. The agency cited Italy's large increase in debt, consistently low growth and lack of competitiveness as reasons for the downgrade. The agency also revised down the country's growth outlook, predicting 0.2 percent growth in 2015 – below earlier predictions of 1.1 percent.

S&P said the credit outlook for Italy was stable, reflecting expectations that the government would gradually implement "comprehensive and potentially growth-enhancing" structural and budgetary reforms.

Merkel weighs in

Adding insult to Italy's injury, however, German Chancellor Angela Merkel told Die Welt on Sunday that countries like Italy and France needed to enact additional measures to ensure their 2015 budgets were in line with European Commission rules, Reuters reported.

Her comments prompted Sandro Gozi, Italian undersecretary for EU affairs, to retaliate, stating that it was not up to Germany to hand out "marks" on its fellow euro zone neighbors' economic performance. In fact, he said, Germany should focus on its own problems, and do more to stimulate the region's growth.

'ECB-driven debt market'

The criticism is likely to irk Italian Prime Minister Matteo Renzi, who has tried to implement a number of reforms after becoming head of the country in February. Italy, the euro zone's third-largest economy, is still mired in recession and has a debt-to-GDP (gross domestic product) ratio of just over 130 percent.

Despite S&P's downgrade and some concerning economic indicators, however, the yield – or interest rate – on Italy's government debt has been steadily falling over the year to date. It comes as markets continue to speculate that the European Central Bank (ECB) will launch additional stimulus plans to support the 18-country euro zone area, including buying sovereign debt.

Read MoreECB considering broad QE package for next meeting: Source

The yield on Italy's 10-year government bonds dipped below 2 percent for the first time last week and on Monday were trading around 2.0 percent.

Although the ECB disappointed some analysts at its monetary policy meeting last week by announcing no new stimulus programs, the central bank is now expected to announce a full-blown quantitative easing program, including the purchase of government debt, in early 2015.

"The key metric here is what investors think will be coming down the track from the ECB, that's the reality," Jeremy Stretch, head of FX strategy at Canadian Imperial Bank of Commerce, told CNBC Monday.

Read MoreGoldman sees 50% chance of ECB QE

"If investors think there will be purchases coming from the ECB down the track early in the first quarter of 2015 then you'll continue to see interest in (countries like Italy)."

While Nicholas Spiro, head of Spiro Sovereign Strategy, said markets would view S&P's downgrade of Italy as "pretty much irrelevant".

"Whether Italy is rated two notches above 'junk' or just one, which is now the case following Friday's downgrade by Standard & Poor's, is pretty much irrelevant to financial markets," Nicholas Spiro, head of Spiro Sovereign Strategy, said in a note Sunday. "When markets open Monday morning, it's highly unlikely that there'll be much of a reaction to S&P's move in Italy's ECB-driven debt market."

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt. Follow us on Twitter: @CNBCWorld.