Weaker bank stocks led European shares lower on Friday, unsettled by new signs the United States may fail to reach a deal to avoid growth-sapping fiscal measures.

Equities fell after the US Republican party failed overnight to back a plan aimed at averting a "fiscal cliff" of tax hikes and government spending cuts at the New Year.

Most investors said they still expected US politicians to reach a deal eventually, but traders were wary of buying new equity positions before the end of the year.

The pan-European FTSEurofirst 300 index, which had risen to a 19-month of 1,144.15 points earlier this week, dipped 0.3 per cent to 1,139.17 points, with a decline in major bank stocks contributing to the slide.

The euro zone's blue-chip Euro STOXX 50 index also retreated by 0.3 per cent to 2,651.09 points.

Berkeley Futures associate director Richard Griffiths said most investors were still "long" on the market, expecting further gains in January and a deal on the US "fiscal cliff" by then.

Griffiths said Germany's DAX, which fell 0.5 per cent to 7,636.23 points on Friday, could rise to 7,800 points in January, while the Euro STOXX 50 could rise to 2,725 points.

"The market just stopped in its tracks after that unexpected announcement last night," said Griffiths.

"But it's showing resilience. It's not down by that much and people think it's just a delay before they reach a deal in maybe three weeks' time," he added.

Banks stocks fall

Aeroports de Paris, which runs the French capital's main airports, was the worst-performing stock on the FTSEurofirst 300, falling 5.4 per cent after cutting earnings targets.

The STOXX 600 European banking index was also among the worst-performing sectors, declining 0.9 per cent with UK bank shares falling after a parliamentary report warned the industry may need tougher regulation.

"It just adds a bit more negative sentiment towards the sector," Securequity sales trader Jawaid Afsar said of the parliamentary report.

European equity markets are set to end 2012 with solid gains, helped by a pledge from the European Central Bank (ECB) in July to offer conditional help if vulnerable euro states request it.

The FTSEurofirst 300 and Euro STOXX 50 are up around 14 per cent since the start of 2012, while Germany's DAX has risen nearly 30 per cent.

However, the U.S budget crisis has kept equity markets choppy this month, with the Euro STOXX 50 Volatility Index rising 13.6 per cent on Friday.

HED Capital head Richard Edwards recommended that investors go long on the DAX, betting on further gains on that market, while going short on Spain, Italy and Greece, anticipating falls in the stocks of these weaker economies.

He expects many fund managers to err on the side of caution and sell equity holdings to lock in profits before the end of 2012. "You get an awful lot of cascade-selling before the year-end."

Reuters