Investors are positioning for another potential political shock in next week’s Italian referendum.

The vote takes place on December 4th and has been cited as a key event for political stability and Italy’s future.

Prime Minister Matteo Renzi has pinned his political career on asking Italians if they support his plan to overhaul the country’s national constitution.

A “yes” vote on December 4th should reinforce Renzi's mandate and allow him to push forward with his economic reforms.

However if Renzi were to lose by a hefty margin, he’d likely step down. 

That could mean the populist Five Star Movement, the country’s largest opposition group, make some significant gains.

“Although the Italian constitutional referendum may seem parochial compared with the US election or the Brexit vote, it has the potential to bring further uncertainty to a European Union (EU) which is already struggling to digest the implications of Trump’s victory,” said David Zahn, head of European fixed income at Franklin Templeton Investments.

Céline Renucci, research & investment strategy at Axa Investment Managers said the vote is “hopefully the last” 2016 political event that could trigger an important financial market reaction. 

Renucci’s central scenario is a "no" vote that would not lead to a political crisis, as the firm expects either Renzi to stay, or the existing coalition to quickly form a new government.

Such an outcome would likely trigger another widening of Italian bond spreads (+20bp versus Bund) but to a limited extent as most of the impact is possibly already priced in.

It should also weigh on financials, in a context where spreads have already widened and the Italian banking system remains highly fragile.

A more critical scenario would be if the referendum rejection turns into a political stalemate after the current coalition breaks up, leading to a sharp spread widening (+150bp versus Bund), and a further deterioration in the Italian banks’ situation.

Renucci adds that a large “no” may seriously complicate matters, with financials loosing values, raising difficulties for private sector capital funding. 

A tail risk, if this was materialising, would have implications for the European banking sector more largely given the degree of cross-border bank exposures 

At the moment, it seems as though the “no” vote has the edge by a small margin, although there is a large group of undecided voters. 

Italian law prohibits the publication of official opinion polls in the two weeks leading up to an election, so there’s likely to be little guidance for markets next week.