The FTSE 100 <.FTSE> fell on Friday, retracing earlier gains, on reports that debt ratings agency Standard & Poor's was set to downgrade a number of euro zone countries.

A senior euro zone government source said S&P would cut credit ratings for several euro zone countries later on Friday, although not for Germany or the Netherlands. S&P declined to comment.

The big question, said traders, was what would happen to the AAA status for the European Financial Stability Facility, the EU bailout fund, if France, the EFSF's second-biggest contributor after Germany, was downgraded?

A lacklustre sale of Italian debt also took its toll on investor sentiment. Italy sold 4.75 billion euros of government bonds in an auction which analysts said did not go as well as some people had expected.

The FTSE 100 <0#.FTSE> closed down 25.78 points, or 0.5 percent, at 5,636.64, off an earlier low of 5,583.45 which was plumbed in initial reaction to the reports of euro zone ratings cuts, taking its weekly fall to 0.2 percent.

I don't think people are ready yet to throw in the towel, Phil Roberts, chief European technical strategist at Barclays Capital, said.

To actually turn the short-term picture much more negative the FTSE would have to drop back below 5,590 (the base of January's tight range), he said.

Strong banks <.FTNMX8350> limited the FTSE 100's losses, led by a 4.8 percent rise from Royal Bank of Scotland , which announced a major restructuring on Thursday, as Seymour Pierce turned its rating on the stock to a buy from a reduce.

The sector's gains came as U.S. peer JPMorgan Chase reported fourth-quarter earnings in line with expectations, according to Thomson Reuters data.

Tesco shed a further 2.1 percent, having plunged 16 percent the previous session after the retailer's unprecedented profit warning, as a number of brokers issued downgrades.

Among them, UBS cut its rating on the stock to neutral from buy, while Credit Suisse's recommendation moved to neutral from outperform.

UBS said in a note: Lower forecasts naturally result in a reduction in our price target. Furthermore, the likely delay in evidence of improving returns and the lag in Tesco's remedial action delivering tangible results means that we think an imminent re-rating is now unlikely.

Trading volume in Tesco was robust, at almost six times its 90-day daily average, with volume on the FTSE 100 at only one and a half times.

A profit warning also heaped pressure on midcap engineer Invensys , with the shares down more than 19 percent after the company said its results would be hit by higher costs in its rail division and in work on Chinese nuclear reactors.

The profit warning in Invensys today after yesterday's debacle from Tesco shows that individual stock risk is still very high, said Lex van Dam, hedge fund manager at Hampstead Capital, which manages $500 million of assets.

A market to still be very careful of, he added.

(Editing by Greg Mahlich)