The coalition, formed after former president Pervez Musharraf's allies lost a February parliamentary election, has looked increasingly precarious since Musharraf resigned a week ago.

The Pakistan People's Party (PPP) of assassinated former prime minister Benazir Bhutto, the leading coalition partner, has been unable to reach an agreement with its main partner, former prime minister Nawaz Sharif's party, on the restoration of judges Musharraf purged last year.

Another divisive issue is who should be the country's next president.

The PPP announced on Saturday that Bhutto's widower and political successor, Asif Ali Zardari, would be its candidate.

Sharif's party, which has repeatedly threatened to leave the coalition if the judges are not restored, was meeting on Monday afternoon to consider its position and was due to hold a news conference at 6 p.m. (1 p.m. British time).

As the politicians bicker, militant violence has surged.

Pakistani Taliban gunmen attacked a district government official's home in the Swat Valley, northwest of Islamabad, on Monday, killing three family members and seven guards, police said.

Signalling what could be a new Taliban tactic to undermine foreign forces in Afghanistan, gunmen in the port city of Karachi set fire on Sunday night to two armoured vehicles bound for U.S. forces in Afghanistan.

RUPEE AT NEW LOW, STOCKS DOWN

The violence and political uncertainty, on top of weak economic data, have undermined investor confidence and sent the country's financial markets sharply lower.

The Pakistani rupee closed at a record low of around 76.60/70 to the dollar on Monday. Shares were nearly 2 percent lower.

Pakistan's stock market, which rose for six consecutive years to 2007 and was one of the best-performing markets in Asia in that period, has fallen about 30 percent this year.

The government banned the main Pakistani Taliban group on Monday, making fund-raising for it illegal, but a militant spokesman dismissed the move as meaningless.

Shortly before the ban was announced, Zardari said in an interview with the BBC the Pakistani Taliban had the advantage.

"It is an insurgency", said Zardari. "It is our country and we will defend it."

"The world is losing the war. I think at the moment they definitely have the upper hand," Zardari said of the militants accused by the previous government of being behind the December 27 assassination of his wife in a suicide attack.

Fear of violence is hurting not only Pakistan's economy.

Next month's Champions Trophy cricket tournament in Pakistan was postponed for 13 months on Sunday after five of the eight nations due to take part confirmed they would not send a team because of security concerns.

If Sharif's party were to leave the coalition it would not force a general election as the PPP should be able to gather enough support to govern, analysts say.

But it would make it more difficult for the PPP to marshal a two-thirds majority in parliament, needed to amend the constitution.