More central bank intervention is likely as governments try to arrest the fall of the dollar.
If that fails, analysts fear that the US Federal Reserve will be forced to increase interest rates to protect the currency, driving share prices to new 1994 lows.
More than pounds 33bn was wiped off share prices last week, as the FT-SE 100 - the key index of the 100 biggest quoted companies - dived 146 points. Some pounds 15bn of that was lost on Friday alone, when concerted central bank intervention failed to halt the dollar's slide, and the market fell by 66 points to 2,876, a new low for the year.
Share prices on Wall Street continued to slide after the London market closed, adding pressure on UK market makers - the wholesalers of shares - to mark prices down first thing tomorrow morning. The 34- point slide in the Dow Jones Industrial Average at lunchtime had worsened to a 62-point decline by the close of trading, leaving the Dow at 3,637.
Marcus Grubb, chief international strategist at Salomon Brothers in London, said: 'I think it does not look good. Markets are stuck in a cycle of inflation fear and the weak US dollar. My worry is that equities will be crushed in a vice between rising bond yields on the one hand and the effect on company earnings of a weak dollar and high bond yields on the other. I think the Fed is probably going to have to tighten to go against the crisis in the dollar.'
Salomon analysts have been downgrading profit forecasts for UK companies with businesses in the US because of the effect of the weak dollar. They have also been reducing expected bank profits to reflect likely losses on bond portfolios.
On Friday, the dollar spiked higher on intervention, rising to around Y101.80 against the yen. But central banks found plenty of willing sellers, and the dollar closed in London at Y100.7.
Despite the gloom, sentiment could quickly change: eight out of 10 market experts canvassed by the Independent on Sunday last week expect the stock market to end the year higher than it is today. The most sanguine is Roger Nightingale, economist at stockbroker WI Carr, who believes the Footsie will soar to 4,000 by the year-end.
Martyn Arbib, chairman of the unit trust group Perpetual, said on Friday 'We are getting ready to put money into equities. I expect shares to fall a bit more. If they do, I'll be buying, perhaps as early as next week.'
While the stock market remains shrouded in gloom, the real economy looks brighter. Kenneth Clarke will this week revise the forecasts for the economy that he outlined in November's Budget, raising his prediction for growth this year and cutting his forecast for inflation.
The City will be keen to see whether this allows him to make a forecast for government borrowing over the next few years. Too optimistic a forecast could trigger demands from Conservative backbenchers for tax cuts.
The Chancellor will announce that he expects underlying inflation to average 2.5 per cent in the fourth quarter of this year, compared with the 3.25 per cent predicted in the last Budget. He will also forecast that national output of goods and services will have grown by 2.75 per cent this year, compared to the 2.5 per cent he predicted in November.
The combination of unexpectedly high growth and surprisingly subdued inflation should allow the Chancellor to cut public spending. Lower inflation means that the same amount of goods and services can be bought for less cash than budgeted, and that benefits do not need to be increased as much to keep pace with prices. Unexpectedly high growth and falls in unemployment mean fewer people claiming benefits, which also reduces spending.
But Darren Winder, of Warburg Securities, predicts in a new study that public borrowing will fall much more quickly than the Treasury forecasts.
Mr Winder argues that economic recovery alone will cut the PSBR by pounds 20bn between now and 1997/8. Combined with discretionary tax and public spending changes, this should bring the Government's finances back into the black by 1997/8 with a surplus of pounds 6bn, when the Treasury is still forecasting a pounds 12bn deficit.
'How this growth dividend will be allocated is unclear,' Mr Winder argues. 'But given the Government's current tough position on public spending, lower taxes appear to be the strong favourite'.Reuse content