The FTSE fell on Wednesday after comments from a German government official eroded optimism about a comprehensive deal to solve the euro zone's debt crisis at this week's crunch EU summit.
The FTSE 100 index <.FTSE> ended down 21.81 points, or 0.4 percent, at 5,546.91, after a choppy day when the index hit an intra-day high of 5,631.88.
The senior German government official, briefing reporters on condition of anonymity, said Berlin is increasingly pessimistic about the chances of a deal, accusing some governments of failing to grasp the gravity of the situation.
This took the steam out of an early rally from the UK benchmark inspired by a Financial Times report that eleventh-hour talks had begun to create a bigger financial bazooka to present to the European Union Summit on Thursday and Friday.
The markets are very nervous ahead of the summit. They realise that in the past European officials have over-promised and under-delivered -- there's absolutely no room for disappointment this time around, said Henk Potts, market strategist at Barclays Wealth.
We have to get the comprehensive plan, and we have to get the details of that. Without that then of course markets have the potential to go back into reverse again.
Joshua Raymond, market strategist at City Index, said: There is every chance that with the stakes so high and all investor attention towards developments in Brussels, we could see a very edgy and nervy market over the course of Thursday and Fridays sessions, with prices reacting to all news, rumour and speculation out of Belgium.
Riskier assets such as banks <.FTNMX8350> and insurers <.SXIP>, which stand to benefit most from a successful debt package as it would shore up confidence in the financial system, ended the day in negative territory.
Traders said that any surprises from the European Central Bank, which holds its last monetary policy meeting for the year on Thursday -- with an expectation for a rate cut -- could also trigger sharp moves in the markets.
Traders said the downgrade include a 2012-13 forecast for reduced earnings in the European banking sector by 7-9 percent to reflect the impact of further de-leveraging and weaker underlying economic prospects.
Despite a likely recession in the euro zone next year, Citigroup said it remained bullish on European equities, which it said are poised to deliver returns of 15-20 percent in 2012.
The bank said this is down to cheap valuations, expected policy changes in the region and with no global recession in sight, although it leaned towards defensives in selecting favoured stocks.
Citigroup said it favoured industries with international exposure and low leverage, and was overweight on health care, oil and gas, basic resources, personal and household goods insurance and food and beverage companies.
Among FTSE 100 risers, Burberry
Burberry has reached an inflexion point. After more than a decade of restructuring, the cost of sorting out legacy issues and investment in a growth platform is set to fade as both sales and margins accelerate, Liberum said in a note.
Ex-dividend factors clipped 0.43 point off the FTSE 100 index, with AB Foods
Investec could also be one of three companies to leave the FTSE 100 when the latest quarterly reshuffle of the index is announced after the London market close on Wednesday.
(Additional reporting by David Brett and Jon Hopkins; Editing by David Cowell)