Negotiations on the UK's proposed EU reform demands have made "no real progress" so far, Downing Street sources told the BBC.
The EU Council meeting broke up for a late working dinner with "significant gaps" still not overcome. The leaders are expected to resume talks.
David Cameron has told EU leaders he is ready to walk away from a crunch Brussels summit without a deal on Friday unless they give ground on key British demands and provide him with a "credible" package he can sell to voters in the upcoming referendum.
The Prime Minister urged fellow leaders to agree a new "live and let live" settlement which could resolve the "festering" problem of Britain's relationship with Europe for a generation.
But as the first session of talks broke up after two and a half hours, a Downing Street source said there was little sign of narrowing in differences over a number of key issues like migrant welfare, relations with the eurozone and the requirement for "ever-closer union".
With officials preparing for a tough night of bargaining before leaders return to the negotiating table at breakfast-time, the possibility remained that a summit described as "make or break" by European Council president Donald Tusk could end without a breakthrough, almost certainly delaying a referendum until after the summer.
"The Prime Minister left them in no doubt that we are only going to do an agreement at this summit if we make some real progress from where we were at 8.30 this evening," said the Number 10 source. "If we don't, we are not going to have an agreement at this summit.
"There is some real hard work to do overnight and we have got to see real progress."
Despite a string of European leaders, including German Chancellor Angela Merkel, saying they were ready to be constructive about finding a resolution to Britain's concerns, the Downing Street source said Mr Tusk shared the PM's assessment that more movement was needed to secure a deal.
"While many countries said they wanted to help keep Britain in the EU, there wasn't much sign of how they are planning to do that in practice," said the source.
Mr Cameron was meeting Mr Tusk after the summit dinner to discuss the work that was needed overnight, and was ready to talk to other leaders.