A profit warning from Saipem caused shares in Europe's biggest oil services company to fall 34.3 percent and sent shockwaves through the oil & gas sector.

Imperial Tobacco, meanwhile, shed 4.3 percent after guiding for lower profits.

They both weighed on the pan-European FTSEurofirst 300 index, which closed 0.6 percent lower at 1,171.09 points, chalking up the worst daily loss since Dec. 28.

The index, which remained on course to record its best month since July last year, was retreating from a 2-year high hit the day before, which had left it in "overbought" territory on its 14-day Relative Strength Index.

"Surely this is a little bit of a wake up call to this never-ending market rally," Dermot Corrigan, head of derivatives trading firm, Qubed Derivatives, said.

"The (cash) market is well overbought, so a correction would be healthy. With volatility at these levels protection isn't expensive."

Corrigan was positioned for a rise in the volatility of option prices, which typically shows investors are trading options to protect themselves from swings in the cash market.

Volatility on euro zone blue chips, as measured by Euro STOXX 50 Implied Volatility index, rose 7.3 percent, rebounding from lows not seen since 2007.

The underlying Euro STOXX 50 index fell 0.6 percent to 2,732.12.

US. HIT

Indexes extended losses in the afternoon as data showed the U.S. economy unexpectedly contracted in the fourth quarter, suffering its first decline since the recession ended more than three years ago.

"We do not expect a recession, i.e. another quarter with falling GDP, but a strong rebound also looks unlikely in our view," Joost van Leenders, investment specialist for allocation & strategy at BNP Paribas Investment Partners.

He added concerns about the U.S. economy, exacerbated by the forthcoming debt ceiling negotiations, and disappointments on the earnings front could usher in a fall of up to 10 percent on European indexes.

While much of the fall was seen as due to temporary factors, the report would likely provide ammunition for officials at the U.S. Federal Reserve to stay on their ultra-accommodative policy stance, which has helped fuel a 27 rally in the Euro STOXX 50 since June.

As a two-day policy meeting draws to an end, the Fed's Federal Open Market Committee was not expected to signal an early end to its quantitative easing programme, keeping its printing presses working at full speed as policy-makers in Washington prepare for new fiscal negotiations next month.

"(The Fed's chairman Ben) Bernanke has been worried about the fiscal cliff and I think he's not going to do anything until that danger is lifted," Alistair Winter, investment strategist at Daniel Stewart, said.

Traders cited continued money printing from the Federal Reserve as a key factor helping lift the euro and keep European equities near 2-year highs.

Societe Generale added the meeting ending on Wednesday could show the Fed's Federal Open Market Committee would take an even more accommodative stance as four voting seats on the policy panel will change hands.