UK's FTSE retreats as Ukraine tension grows

* FTSE 100 falls 0.4 percent

* Ukraine says Russian troops back rebel advance

* Steady German inflation leaves open risk of euro zone dip

* Mining stocks hit by fall in iron ore prices

* Morrisons, CRH (NYSE: CRH - news) lifted by analyst upgrades

By Tricia Wright

LONDON, Aug 28 (Reuters) - A ratcheting up of tension in Ukraine took its toll on Britain's top share index on Thursday, knocking it back from its highest closing level in nearly two months.

Ukrainian President Petro Poroshenko said Russian forces had entered his country and the military conflict was worsening after Russian-backed separatists swept into a town in the east.

The blue-chip FTSE 100, which on Wednesday had risen to its highest close since early July, ended down 24.86 points, or 0.4 percent, at 6,805.80 points.

Concerns over the situation in Ukraine overshadowed a trio of positive data releases out of the United States. Its economy rebounded more strongly than initially thought in the second quarter, jobless claims fell for a second straight week, and July pending home sales rose far more than had been expected.

"We see overall some exhaustion within the FTSE and expect to see this consolidation pattern trade to the downside," Atif Latif, director of trading at Guardian Stockbrokers, said.

Miners were the biggest fallers by some margin. The FTSE 350 Mining Index fell 2.7 percent, with mining company Rio Tinto (Xetra: 855018 - news) weakening by 3.8 percent on a drop in iron ore prices.

Investors, meanwhile, remained focused on European Central Bank policy in the wake of ECB President Mario Draghi's dovish remarks in a speech at Jackson Hole, Wyoming, last week.

Annual inflation in Europe's largest economy held steady in August, data showed. That suggested there is still a risk the euro zone rate will fall and increased the dilemma for the ECB over whether to take action.

ECB sources told Reuters on Wednesday new policy moves were unlikely at the bank's meeting next week, unless August inflation figures, due on Friday, show the euro zone sinking close to deflation.

The FTSE has risen around 4 percent in the past 2-1/2 weeks, helped by the expectations of ECB stimulus. The index climbed to 6,894.88 points in mid-May, its highest level in more than 14 years. But it has not passed 6,900, considered a key hurdle before the FTSE can challenge record highs around 7,000.

Kyri Kangellaris, managing director at Strand Capital, said he would look to "short" the FTSE at current levels - namely take bets on a pull-back.

"I think it's a pretty good shorting opportunity at these levels," he said.

Among the brighter spots on Thursday, Irish building supplies group CRH rose 2 percent, the top blue-chip riser, on a double-upgrade from Credit Suisse (NYSE: CS - news) to "outperform" from "underperform" on valuation grounds.

And supermarket chain Wm Morrison advanced 1.4 percent, bolstered by a Deutsche Bank (Xetra: 514000 - news) recommendation upgrade to "hold" from "sell". It reckons Morrisons will report in-line first-half results on Sept. 11.

There were some wild moves among FTSE 250 stocks. Industrial inkjet company Xaar (Other OTC: XAARF - news) dropped 21.6 percent after cutting its annual revenue forecast again.

CSR (LSE: CSR.L - news) leapt 35.7 percent after it rebuffed an approach from U.S. rival Microchip Technology (NasdaqGS: MCHP - news) . (Additional reporting by Sudip Kar-Gupta; Editing by Alison Williams)