In a report confirming that the ECB is preparing for a rerun of a post-Brexit scenario, Reuters writes that the ECB is ready to temporarily step up purchases of Italian government bonds if the result of next Sunday's crucial referendum, which according to WSJ will likely determine the future of not only Monte Paschi but other insolvent Italian banks, "rocks markets" and sharply drives up borrowing costs for the euro zone's largest debtor.

As observed here over the past week, Italian government bonds and bank shares have sold off steeply ahead of the Dec. 4 referendum on constitutional reforms as the market has grown to appreciate the risk of political turmoil. Opinion polls suggest the 'No' camp is heading for substantial victory, which could force out Prime Minister Matteo Renzi in the latest upheaval against the ruling establishment sweeping the developed world. Heavily indebted Italy's borrowing costs are closely watched as a potential flashpoint for market instability in the wider euro zone.

Just like in the hours after the Brexit announcement, when the ECB and other regional central banks vowed to step in and stabilize markets, the ECB will likely use its €80 billion monthly bond-buying program - which already hold nearly €1.2 trillion in European bonds - to counter any immediate, further spike in bond yields after the vote, smoothing market moves and supporting bonds, according to four euro zone central bank sources who asked not to be named.

The sources added the scheme was flexible enough to allow for a temporary increase in Italian purchases and that such a move would not necessarily need to be rubber-stamped by the ECB's Governing Council, which is due to meet on Dec. 8 to decide on whether to keep buying bonds after March. But they stressed this would be limited to days or weeks, to counter any immediate market volatility, because the asset-purchase program was designed to shore up inflation and economic growth in the entire euro zone and was not intended to fight crises in individual countries. This means that, if Italy or its banks needed longer-term financial support, Rome would need to formally ask for help. "The Governing Council understands that there is some space to help Italy, which will be used, if needed. The asset purchase program has built-in flexibility," said one of the sources. "The key is that the ECB has to be convinced the volatility can be overcome by using this flexibility."

Last week ECB Vice President Vitor Constancio opened the door to a central bank intervention last week but also stressed that still-low Italian bond yields did not point to investor fears that the country may crash out of the euro zone. Indeed, concerns about deposit flight and the health of Italian banks, rather than Italy's own borrowing costs, have become Rome's biggest worry in the aftermath of a 'No' vote.

Italy's 10-year bond yields stand at 2% the highest level in more than a year but nowhere near the 7% level that prompted emergency ECB purchases in 2010-11 and eventually led to the resignation of Prime Minister Silvio Berlusconi, when Draghi refused to intervene in capital markets in a show of force with the then-Italian PM to demonstrate who is the real boss.

Reuters also adds that Euro zone central bank sources say there is little the ECB can do about the banks' need for capital unless Italy itself asks for a rescue program for its banking sector. This would also unlock further, country-specific ECB purchases of Italian debt, known as Outright Monetary Transactions (OMT). These, unlike the current asset-purchase program, are not tied to the "capital key", or how much capital each country has paid into the central bank.

"There is a risk that a bout of volatility would have a broader impact on the bank sector," one of the sources said. "At that point, it's not for the ECB to act. That's typically where OMT needs to come in with all the requirements, including a (rescue) program."

Logistic aside, BTP futures briefly spiked higher, gaining ~30 ticks in 2 minutes, to session high of 135.46, after Reuters cites unidentified sources to report ECB ready to temporarily step up Italy bond purchases if referendum causes yield spike.