Vladimir Putin has called for talks over the crisis in eastern Ukraine as European Union leaders threatened a fresh wave of sanctions over the "unacceptable" incursion by troops from Russia into its neighbour.
European leaders have ordered officials to make urgent preparations for a toughening of measures, likely to target senior Kremlin figures as well as the defence, energy and financial sectors, amid concerns the crisis was reaching the "point of no return".
The Russian president said Ukraine should begin "substantive, meaningful talks" about the future of the country's eastern region, where pro-Moscow separatists have been clashing with forces loyal to the Kiev government.
He said he Ukraine should launch discussions with the separatists " not about technical issues but about the question of the political organisation of society and statehood in south-east Ukraine, with the goal of safeguarding the legitimate interests of those people who live there".
Mr Putin's officials insisted that despite the use of the word "statehood", Mr Putin did not envision sovereignty for the two separatist eastern regions that style themselves as "Novorossiya" or New Russia.
Defence Secretary Michael Fallon insisted that sanctions were already having an impact on the Russian economy and called for Nato countries to match the UK in meeting their commitments to defence spending in order to combat the "threat now here on our own doorstep".
He told Sky News' Murnaghan programme: "The European leaders were very clear last night that if Putin does not stop the incursions that we have seen over the border now - there's real evidence of troops and vehicles being moved across the border into Ukraine, into sovereign Ukrainian territory - if he does not stop those incursions then he is going to face further sanctions."
Although Ukraine is not a member of Nato, its president Petro Poroshenko will join leaders of Nato nations at this week's summit in Wales, where Mr Fallon said efforts would be made to reassure the alliance's eastern members.
British troops will take part in a series of large-scale exercises in former Eastern Bloc countries in an effort to demonstrate the alliance's commitment to them.
Mr Fallon said: " The president of Ukraine will be at the Nato summit this week. Ukraine is not yet a member of Nato.
"They are now looking at whether they should join Nato.
"What we will be doing at the Nato summit is getting the other members of Nato to focus on what more can be done to reassure eastern members of Nato, particularly the Baltic states, Poland and Romania, by way of more large-scale exercises.
"I have authorised the deployment of an entire battle group to take part in a new exercise from September right through to December in Poland. There are going to be over 3,000 British troops involved in these countries this year and next year, larger-scale exercises.
"And we've also got to get the Nato countries to spend more on defence."
Although the UK was meeting the commitment to spend 2% of GDP on defence, other members of the alliance were falling short, he said.
"We simply can't leave this to the Americans, this is a threat now here on our own doorstep."
The Prime Minister said the EU summit in Brussels had taken "important steps" and the European Commission (EC) would present firm proposals for tougher sanctions within a week.
"It is totally unacceptable that there are Russian soldiers on Ukrainian soil. We have now set out a timetable for further sanctions that could be ... significant steps," Mr Cameron said.
"It's a deeply serious situation and we have to show real resolve, real resilience in demonstrating to Russia that if she carries on in this way the relationship we have between Europe and Russia, Britain and Russia, America and Russia will be radically different in the future."
At a joint press conference with Mr Poroshenko in Brussels yesterday, outgoing EC president Jose Manuel Barroso insisted it was not too late to find a political solution. But he added: "We are in a very serious, I would say, dramatic situation ... where we can reach the point of no return.
"If the escalation of the conflict continues, this point can come."
He added: "Russia should not underestimate the European Union's will and resolve to stand by its principles and values."
Mr Poroshenko said his presence at the summit was an important demonstration of solidarity with his country and said he still hoped tensions could be eased, after meeting Mr Putin in Minsk earlier this week.
"The most important thing now is peace," he said. "Today we are talking about the fate of Ukraine, tomorrow it could be for all Europe."
Explaining his words later, Mr Barroso said he feared tit-for-tat sanctions would "make it impossible to re-establish the kind of relations that are in the interests of both the EU and Russia" - adding that no one wanted to return to Cold War style animosity.
Lithuanian president Dalia Grybauskaite, whose country used to be part of the Soviet Union, suggested EU states should be supplying Kiev with military equipment.
"It is the fact that Russia is in a war state against Ukraine," she told reporters. "That means it is in a state of war against a country which would like to be closely integrated with the EU. Practically Russia is in a state of war against Europe.
"That means we need to help Ukraine to ... defend its territory and its people and to help militarily, especially with the military materials to help Ukraine to defend itself because today Ukraine is fighting a war on behalf of all Europe."
But UK government sources echoed Mr Poroshenko's view that there was "no military solution" to the crisis. In their communique from the summit, the leaders stated that they were "ready to take significant further steps, in light of the evolution of the situation on the ground".
"We request the commission to urgently undertake preparatory work ... and present proposals for consideration within a week," they said.
Mr Putin has denied that his forces are in Ukraine and called on Ukraine to stop its offensive against the separatist rebels.
"If anybody believes that in a situation where the cities and villages of east Ukraine come under direct fire that the militiamen will have no reaction to that, but will simply wait for the promised talks, then these people are prisoner to some illusions," he said.