France's President Nicolas Sarkozy (C) sits next to German Chancellor Angela Merkel (L) and European Commission President Jose Manuel Barroso.

With the euro already down against the dollar and stocks hit hard from New York to Tokyo, Prime Minister Donald Tusk of current EU chair Poland had warned beforehand that failure to convince Britain to sign up would mean the "coffin" for post-WWII EU integration.

But just after 3:30 pm (0230 GMT), a senior diplomat told AFP that "Britain is out of the discussion" about rewriting the EU's Lisbon Treaty -- meaning eurozone leaders were left trying to construct a different inter-governmental agreement amid some doubts over its legal strength.

After repeated warnings from London, the decision to change track came after British Prime Minister David Cameron demanded paybacks such as a veto on EU financial regulation that partners were not prepared to grant.

Cameron has vowed to protect the City of London, home to 75 percent of Europe's entire financial services industry, with France and Germany also leading EU moves to impose a financial transactions tax.

Treaty change requires unanimous approval from the bloc's 27 nations, and Cameron warned in an article in The Times of London this week that Britain could challenge the right to put EU institutions to work on shoring up the euro -- potentially at the expense of its neighbour but partner in the world's biggest border-free market.

The European Commission and the European Court of Justice "belong to all EU states and their use outside the treaty of the 27 would clearly require safeguards", Cameron stressed.

A senior EU official said that "legal advice was sought during the discussions".

The row took any shine off tentative steps to ensure countries would set "balanced" budgets until debt levels drop.

The so-called "golden rule" was only agreed "in principle", despite proposed "automatic consequences" for eurozone countries that break the long-ignored rule that budget deficits must be under three percent of gross domestic product (GDP).

Countries' "annual structural deficit" could reach 0.5 percent of GDP, rather than zero, draft conclusions seen by AFP said.

The "structural" deficit is one calculated minus one-off factors such as debt repayments and the effects of the economic cycle.

However, several sticking points in the wider "fiscal compact," the first steps towards a tax-and-spend union, remained according to diplomats over the finer detail of agreeing the legal language required.

Difficult talks began on a sour note when European Central Bank president Mario Draghi sent markets falling when he said hoped-for ECB action to buy up the sovereign bonds of debt-wracked countries was "limited" and "temporary".

Despite the ECB cutting interest rates for a second time and easing further access and repayment conditions for bank funding, Draghi also said a plan for national central banks to fund the IMF to the tune of up to 200 billion euros would also raise "complex legal issues".

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 they became sucked in like Greece and others beforehand.

The euro dropped against the dollar and Italian stocks fell a steep 4.29 percent while in the United States the Dow Jones also shed 1.63 percent.

"We want them to produce results that relieve markets and the world as it is a very important meeting that could determine the course of the world economy in 2012," Japan's Finance Minister Jun Azumi said after stocks there also opened lower.

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.