German Chancellor Angela Merkel is seen trough a car window as she arrives for an informal dinner gathering European Union (EU) heads of State or government.

Difficult talks running overnight began on a sour note when European Central Bank president Mario Draghi, who joined pre-summit negotiations with a restricted power group of Germany, France and leading EU officials, sent stock markets falling.

Draghi said hoped-for ECB action to buy up the sovereign bonds of debt-wracked countries was "limited" and "temporary".

Over the past two years, bond traders have driven up borrowing costs for a succession of eurozone countries.

Markets have been looking to see how European Union leaders would come up with a promised trillion-euro emergency firewall to save Italy or Spain if sucked in like Greece and others beforehand.

Italian stocks fell a steep 4.29 percent and in the US the Dow Jones also shed 1.63 percent. The euro too lost value as investors sold their holdings of the crisis-hit currency.

Diplomats tipped arduous negotiations through the night as five of 27 EU states, including Britain, came out strongly against a German-French drive for a full rewrite of the European Union treaty.

Chancellor Angela Merkel and President Nicolas Sarkozy, who earlier warned there might be "no second chance" for a deal on the euro, have argued full-blown treaty change is the way to reassure markets that eurozone governments will in future live within their means.

US President Barack Obama questioned whether Europe's leaders can collectively "muster the political will" to solve a crisis that Russian counterpart Dmitry Medvedev also said risked hurting the global economy.

Even Pope Benedict XVI said a prayer for the EU.

Earlier, the ECB cut interest rates for a second time and eased further access and repayment conditions for bank funding, on the day the European Banking Authority (EBA) in London increased banks' estimated needs under a recapitalisation drive.

Europe's banks must raise 114.7 billion euros ($152.5 billion) in new capital to restore stability and confidence, the EBA said.

Draghi, though, said a plan for national central banks to fund the IMF, which sources said could inject up to 200 billion euros into bailout funding for Italy or Spain if required, would raise "complex legal issues".

He was adamant that the ECB must not be used simply to print money.

Leading the charge for treaty change, Merkel said leaders must restore "credibility".

But British Prime Minister David Cameron vowed he would torpedo moves to change the rules across the EU to suit the eurozone.

"If I can't get what I want, I will have no hesitation in vetoing a treaty at 27 because I am not going to go to Brussels and not stand up for our country," he said.

Cameron has stressed that powers cannot pass from London to Brussels without a referendum, and also wants the City of London financial sector to be exempt from tough new EU regulation or a proposed tax on financial transactions.

Triple A-rated eurozone Finland also put up blocks, as did Poland, Sweden and Romania.

Obama said Europe's leaders recognised "the urgency of doing something serious and bold" but added: "The question is whether they can muster the political will to get it done."

According to diplomats, leaders did agree to impose stricter fiscal rules including legal or constitutional limits on deficits and automatic penalties for eurozone nations that overspend.

In a first small step towards a tax-and-spending union, they said that "general government budgets shall in principle be balanced."

There was though an additional rejoinder that "country-specific circumstances" would still be taken into account despite a new "automatic correction mechanism" that could be "triggered in the event of deviation".

The executive EU Commission meanwhile would share monitoring of implementation, leaving room as sought by France for political argument.

The summit faces other obstacles, with diplomats saying that Merkel rejected entirely proposals for the eurozone's current and future rescue funds to be added together so as to make available resources bigger.

Berlin also ruled out granting the European Financial Stability Facility (EFSF) a banking licence, allowing it to draw funds from the ECB.

IMF chief Christine Lagarde pledged that her institution would "participate" in the eurozone's efforts, set to run through Friday, and called for "decisive" and "coordinated" action.

The pressure is on after ratings agency Standard & Poor's put a number of large European banks on review and placed the EU and the eurozone on watch for downgrades.