Italy and Spain are holding out on an EU summit deal to bolster growth and jobs until they received a lifeline to reduce their soaring borrowing costs.
European leaders met late into Thursday night as they struggled to come up with a deal that would reassure the volatile financial markets.
The discussions were continuing with the leaders of the 17 eurozone nations after David Cameron and the other leaders of non-eurozone countries broke off from the talks at 1am local time on Friday.
They had hoped to wrap up an agreement on a new 130 billion euro (£104 billion) "compact for jobs and growth" before moving on to discussing long-term reforms to stabilise the eurozone.
However Italian prime minister Mario Monti and Spain's Mariano Rajoy were insisting on support from EU bail out funds to bring down their borrowing rates which have hit unsustainable levels. Their demands put them directly at odds with Germany's Chancellor Angela Merkel who came into the meeting at Brussels insisting there were no short-term fixes on the table.
European Council President Herman van Rompuy acknowledged short-term assistance was necessary but warned it would lack credibility if it was not backed by long-term reform. "In the current climate, a credible perspective for the long-term is essential to restore confidence in the short-term," he said.
The President of the European Parliament, Martin Schulz, addressing the summit earlier had insisted solutions were needed "today as well as tomorrow". He urged leaders to agree "a long-term vision accompanied by short-term pragmatism".
Arriving in Brussels on Thursday , Mr Cameron acknowledged the growing exasperation at the failure of the leaders of the 17 eurozone nations to reach a deal that would stabilise the single currency.
"I know people are frustrated that these summits keep happening and not enough decisions are made," he said. "These are hard decisions for the eurozone countries to make and we should be encouraging them to go ahead."
Following the overnight discussions, Mr van Rompuy said leaders had agreed to use EU bailout funds to directly recapitalise struggling banks, describing the development as a "breakthrough". He also revealed leaders of the 17-nation eurozone had agreed to form a joint banking supervisory body.
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