UK PM David Cameron has effectively vetoed an EU-wide treaty change to tackle the eurozone crisis, saying it was not in the UK's interests.
Instead a new "accord" setting out tougher budget rules will now be drawn up for the eurozone and at least six other EU states which want to sign up.
France's Nicolas Sarkozy said the UK PM had made "unacceptable" demands.
But UK Foreign Secretary William Hague said the move was "very sensible" and would not leave the UK isolated.
He said signing up to a change to the Lisbon Treaty - the treaty which governs the running of the EU - would have meant a loss of national sovereignty.
National budgetsSignatories to the deal will need to have "balanced budgets" - defined as a structural deficit no greater than 0.5% of gross domestic product. There will be automatic sanctions for any country whose deficit exceeds 3% of GDP.
Governments will also have to submit their national budgets to the European Commission, which will have the power to request that they be revised.
Nearly 10 hours of overnight talks could not produce an agreement involving all member states.
French President Nicolas Sarkozy said he would have preferred a treaty change involving all 27 EU members but "that wasn't possible, given the position of our British friends".
Tobin taxMr Sarkozy said Mr Cameron had made "unacceptable" demands for exemptions for the UK over financial services.
The UK has long resisted calls from other EU leader for a Europe-wide tax on financial transactions - a so-called Tobin tax - which it argues would hit the City of London disproportionately.
The BBC's political editor Nick Robinson said the consequences of Mr Cameron's veto "could scarcely be greater for Europe and for Britain's relationship with Europe".
He said there was no denying now that a two-speed Europe - those inside the new deal and those outside - was inevitable and predicted a series of legal challenges about what the new euro "club within a club" could discuss, and whether it should be allowed to use EU resources and officials.
Mr Cameron told a news conference after the discussion that the deal on the table was not in Britain's interest "so I didn't sign up to it".
'Tough decision'"We want the eurozone countries to come together and solve their problems. But we should only allow that to happen within the EU treaties if there are proper protections for the single market, for other key British interests" he said.
"Without those safeguards it is better not to have a treaty within a treaty, but have those countries make their arrangements separately.
"It was a tough decision but the right one."
Mr Sarkozy said the eurozone countries would sign an intergovernmental accord aimed at stabilising the currency in the face of the debt crisis, along with any other EU members that wanted to join.
He said the sticking point had been Mr Cameron's insistence on a protocol allowing London to opt out of proposed change on financial services.
"We were not able to accept [the British demands] because we consider quite the contrary - that a very large and substantial amount of the problems we are facing around the world are a result of lack of regulation of financial services and therefore can't have a waiver for the United Kingdom," he said.
The head of the European Central Bank, Mario Draghi, said the planned accord would lead to much more discipline in economic policy.
'Not isolated'Speaking to BBC Radio 4's Today programme, Mr Hague said the UK had rightly expressed concerns about the implications of the deal and other European countries had made "nothing like enough of an effort to meet those concerns".
He said he "would not use the word isolated" about the decision Mr Cameron had taken, because the new club was not one the UK would want to be part of.
"What they've committed themselves to here is to giving up more national control over their budgets, and us standing apart from that is not being isolated from them, it is a very sensible thing to stand apart from that," he said.
Mr Hague said there were already a number of different groups within the EU who co-operated on different subjects and this would be another case of that.
But he insisted "the decisions of the European Union" would continue to be made in institutions that include all 27 members, and "no treaty made outside of those institutions can undercut or override the treaties of the European Union".
The foreign secretary said Deputy Prime Minister Nick Clegg - who, as leader of the Liberal Democrats, is much more pro-European than Mr Cameron - had "signed up" to the use of the veto.
A spokesman for Mr Clegg said he had been "consulted throughout".
Conservative Mayor of London Boris Johnson told the BBC: "David Cameron has played a blinder and he's done the only thing that it was really open for him to do."
European Commission President Jose Manuel Barroso said he regretted that unanimity on treaty change had not been possible. But he added that it was the "proper decision to go ahead at least with those ready to commit immediately".
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