Former Inter Milan coach Mazzarri joined Watford last May, replacing Quique Sanchez Flores, and guided the club to Premier League safety.
"After the Board discussed with Walter Mazzarri the club's future goals and aspirations, it was decided he will be stepping down from his position as the club's Head Coach after the final game of the 2016/17 season," Watford said in a statement.
"We thank Walter and his staff for the contribution they have made to Watford Football Club over the past year."
Watford are 16th in the table having lost their last five league games in a row.
Mazzarri was the eighth head coach to work under Watford's Italian owner Gino Pozzo, whose family took over the club in 2012.
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