European Central Bank chief Christine Lagarde kept policy steady, as expected, and said the bank expected a pending European Union stimulus scheme to favour grants over loans, as hoped by investors. The bank expects to fully use its huge pandemic stimulus package to help the euro zone stay afloat, she added.
Leaders of the 27 EU states are due to meet on Friday to try to hammer out their differences over how the 750 billion euro recovery fund will operate.
"We do not see an agreement being reached as the base case ahead of this EU summit," said strategists at ING. "We expect some progress towards a compromise being made, but some time for more negotiations is still required."
"This should allow a consolidation of the notion that the EU Recovery Fund will eventually come into existence - without having to be materially re-sized first."
The pan-European STOXX 600 closed down 0.7% after falling as much as 1% during the session. Germany's DAX and France's CAC 40 both cut session losses to end about 0.4% lower.
Italy's FTSE MIB turned positive, boosted by gains in Telecom Italia and Intesa Sanpaolo. Intesa is very confident of a positive outcome to its bid for smaller rival UBI Banca, a company executive said.
Meanwhile, as the number of COVID-19 cases continued to rise in the United States, worries over the economic damage from another round of containment measures persisted.
Unexpected weakness in domestic consumption in China, Europe's major trading partner, and heightened tensions between Washington and Beijing also weighed.
European luxury goods group Richemont fell 4.6% as its quarterly sales almost halved, and it gave no details on current trading or the outlook.
Shares in peers LVMH and Kering, which also rely on China for a large portion of their revenue, fell 1% and 1.3% respectively.
At the bottom of STOXX 600 were shares of Swedish Orphan Biovitrum after the rare diseases specialist's second quarter results missed expectations, while Sandvik, the world's biggest maker of metal-cutting tools, slumped after flagging a slow recovery in demand.
In contrast, German lab equipment maker Sartorius AG jumped 6.3% after raising its full-year forecast.
(Reporting by Sruthi Shankar in Bengaluru; Editing by Shounak Dasgupta and Mark Potter)
By Sruthi Shankar and Susan Mathew