Moody's said the move by Florence in December to use a self-protection clause under Italian law which enables public administrations to annul contracts without seeking legal recourse, was without precedent in Italy.

UBS, Switzerland's biggest bank, Dexia of France and Bank of America have initiated legal action against Florence in a London court.

"Today's rating action is in response to the city's decision to halt payments due on six interest-rate swap contracts with three major banks," Moody's said in a statement, adding that Florence's action was "unprecedented."

Moody's said the payments due were "a residual amount of 173 million euros (244 million dollars)" -- or 30 percent of the city's debt.

It downgraded Florence's debt rating by one notch to Aa3 from Aa2.

Many Italian local governments are in financial trouble because of complex derivatives contracts that went wrong during the global economic crisis.

Italian lawmakers have proposed rules that limit the use of interest rate swaps and local governments are trying to review existing arrangements.