S&P downgraded its rating on Italy by one notch to A/A-1 and kept its outlook on negative, a major surprise that threatens to add to concerns of contagion in the debt-stressed euro zone, and soured the appetite for risky assets.

The benchmark S&P/ASX 200 index fell 45.5 points, or 1.1 percent, to 4,036.00 by 0245 GMT, after sustaining a 1.6 percent fall on Monday.

"We had a very big sell off yesterday in anticipation of a big sell off last night, and the US recovered into the close," said Phillip Weinburg, dealer at Karara Capital.

"Really there is very low volume going through the market and it's just being driven by macro events in particular, looking for headlines on the Greece bailout, but especially in a holding pattern ahead of the two day fed meeting," he added

The Reserve Bank of Australia's September minutes cited the dark outlook for the global economy would help to dampen inflationary pressures at home, a sign that rates could be on hold for some months.

"The RBA is stuck on the fence, so as long as they keep saying they are not going to cut rates yet, people aren't going to get excited, so that's probably why we are off at bit longer," said Chris Kimber managing director Fat Prophets.

Global Miners BHP Billiton and Rio Tinto lead the falls, with Rio Tinto falling 1.5 percent to A$69.12 percent in morning trade on lower metal prices overnight.

New Zealand's benchmark NZX 50 index managed to avoid the market fall out rising 0.15 percent to 3,288.81 mid-session.

STOCKS ON THE MOVE

Uranium producer Paladin Energy suffered some of the biggest losses of the morning, slipping 5.4 percent to A$1.49.

Qantas Airways stocks fell 1.8 percent to A$1.517 as baggage handlers and ground staff stage a nationwide strike, Qantas has cancelled some flights and warned travellers of disruptions.

News Corp stocks bucked the trend rising 1.4 percent in morning trade.

Copyright Reuters, 2011