London's blue chip index closed down 37.42 points or 0.7 percent at 5,612.26, with volumes just 88 percent of their already weak 90-day average and as U.S. equities gave up early gains.

Traders said FTSE 100 bulls also encountered technical resistance around 5,700 -- a level the index failed to hold sustain last week -- and with the relative strength index indicating UK-listed blue chips were approaching overbought territory after last week's 1.4 percent gain.

Banks ebbed lower as investors mulled over the latest press conference from Merkel and French President Nicolas Sarkozy, which traders said was uninspiring.

The main concern revolved around Merkel's warning that Greece would not be paid its next aid tranche without rapid progress on its second rescue package.

These negotiations could go on forever. The chances are this Greek tragedy will go right down to the wire and it will be a case of who blinks first, Richard Driver, analyst for Caxton FX, said.

Banks have already been asked to take a 50 percent haircut on their Greek debt, and there are broader concerns over their balance sheets as European peer UniCredit's capital raising plans failed to convince investors.

For any other European banks that were considering raising new equity via the markets, the performance of Unicredit must have severely put them off, Louise Cooper, markets analyst at BGC Partners, said.

The fundamental problem is one that many banks have a highly leveraged balance sheet compared to the equity value, she said.

With euro zone worries back to the fore, Barclays fell 4.5 percent. Other financial-related stocks were lower too with insurer Old Mutual off 1.4 percent and hedge fund Man Group, which has seen its fund flows adversely impacted by volatile markets, down 4.8 percent.

The FTSE volatility index was up 3.3 percent on Monday and Deutsche Bank warned volatility will remain high in the first few months of the year given the numerous catalysts ahead, notably in Europe.

The European sovereign crisis is far from over ... This should reinforce a geographical divide which has seen U.S. outperforming the rest of the world in 2011.

GLAXO GLOOM

GlaxoSmithkline was among the biggest losers of the day, down 4.1 percent on worries over regulatory approval for its key new once-a-day inhaled lung drug Relovair, after the drugmaker released a batch of clinical trials results.

Shore Capital says the pneumonia signal - GSK will investigate some reports of fatal pneumonia at the highest dose - in chronic obstructive pulmonary disease is concerning and lack of consistency in the pivotal Phase III programme suggests a far from straightforward regulatory passage, particularly in the United States.

Retailers were under pressure after Christmas trading updates from Wm Morrison Supermarkets and HMV, which last month warned it could go out of business, got a mixed reception from investors.

Other British retailers, including Tesco and Marks & Spencer, down around 0.1 and 0.7 percent respectively, are set to report Christmas sales this week, throwing into focus the impact of heavy discounting on profit margins and prospects for consumer spending in 2012.

For a FACTBOX-How UK retailers fared over Christmas, please click on:

With the FTSE 100 retreating, those stocks liked for their defensive characteristics were among the top gainers, with utility National Grid, Burberry and Experian up as much as 2.4 percent