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FRANKFURT (Reuters) - With Italy's constitutional referendum and Austria's presidential vote on Sunday both potentially underlining growing anti-establishmentism, the European Central Bank is preparing to set to try to bring some calm to the mix.
It is expected on Thursday to extend its already generous asset buys, emphasizing heightened risk, including from populist movements that could hijack governments' attention from what it sees as vital reforms.
Polls suggest that Sunday's Italian referendum on what Prime Minister Matteo Renzi says is a vote about streamlining public administration, will likely fail, perhaps bringing down the government and prolonging the county's turbulence.
Austria, meanwhile, may elect the European Union's first far-right head of state in its presidential vote.
Although markets have mostly priced in a "No" vote in Italy, it still comes at a sensitive time as troubled lender Monte dei Paschi (BMPS.MI) is trying to raise 5 billion euros ($5.3 billion) and market volatility could hamper its effort, potentially reverberating throughout the banking sector.
"We expect that under a 'Yes' vote the Italian equity market would have the potential to rally 5 to 10 percent in the short term, whilst a no vote might trigger a 5 to 10 percent correction should Matteo Renzi remain and 10 to 20 percent should the prime minister decide to resign," HSBC said in a note to clients.
The ECB will be ready to step up purchases of Italian government bonds if the referendum drives up borrowing costs but only if the volatility is temporary and the purchases could effectively support the market, sources told Reuters earlier.
But waning confidence in the Italian bank sector may be a bigger issue than sovereign debt yields and policymakers will have little ammunition to prop up the sector.
Indeed, Italian newspaper Corriere della Sera reported on Friday that Italy is in talks with the European Commission on a possible state bailout for Monte dei Paschi, suggesting mixed confidence in the planned capital hike.
Austria's presidential campaign pits a far-right candidate with an establishment pick.
Although the president's role is largely ceremonial, a victory for the Freedom Party's Norbert Hofer would give the far right an important platform, heightening concern about European integration and raising the specter of more gains for populist parties in upcoming elections in France, Germany and the Netherlands.
Meeting amid the political turmoil, the ECB is likely to argue that underlying inflation remains stubbornly weak, so its asset buys will need to be continued beyond March, possibly for another six months, to prop up growth and inflation.
"The Governing Council will also have to consider the implications of political events, such as the outcome of the Italian constitutional referendum on 4 December and the sharp rise in global bond yields which has probably led to an unwelcome tightening of financial conditions in Europe," UBS said.
Indeed, Germany 10-year yields DE10YT=RR are up 35 basis points since mid-October but yields on the currency bloc's periphery are up even more sharply, widening the spread and suggesting increased fragmentation.
Money flowed out of Italy for the eighth straight month in October, ECB data showed, indicating that investors and banks are reluctant to put money into weaker economies despite higher yields, moving cash into countries like Germany, despite punitive rates and negative yields.
Still, the ECB is expected to at least debate sending a formal signal that asset buys will eventually end, a small concession to hawks and an acknowledgment that stimulus cannot go on forever as the ECB has already exhausted much of its firepower, sources told Reuters earlier.
It has already spent 1.4 trillion euros to buy bonds, pushing borrowing costs to record lows, leaving it relatively few assets to buy and raising concerns that such stimulus loses effectiveness over time.
Its new forecasts will also show inflation returning to target by 2019 while the recent oil price surge could also add to calls to ease back on the asset buys.
In other key central bank meetings, the Reserve Bank of India is seen cutting interest rates but the Reserve Bank of Australia and the Bank of Canada are both seen firmly on hold.
Editing by Jeremy Gaunt