Weak banks stamp out FTSE's nascent recovery

* FTSE 100 down 0.5 pct

* UK banks knocked after Fed stress test

* Technical picture precarious, 6,520 seen as support

By Tricia Wright

LONDON, March 27 (Reuters) - Britain's top shares fell on Thursday, reversing tentative signs of a rally, after some UK banks failed U.S. Federal Reserve stress tests.

Royal Bank of Scotland (LSE: RBS.L - news) shed 1.4 percent and HSBC fell 0.5 percent. HSBC's decline knocked 2.5 points off the UK's benchmark index.

The U.S. units of the pair were among banks the Fed blocked from paying higher dividends or buying back their own shares, citing weaknesses in their capital planning.

Traders pointed out discussions about the stress tests are not over, so the banks could get off more lightly than it appears they will.

"It's a watching brief for UK banks this morning, but with any further downside they're likely to attract buyers," said Matt Basi, head of sales trading at CMC Markets.

"All of these things are done by negotiation, so it's not a case of HSBC and RBS making a proposal, the Fed saying no, and that being the end of it. It's a back-and-forth process, and we expect there to be a resolution at some stage in the near-term."

The sector also came into focus after a move late on Wednesday by credit-rating agency Fitch to lower the outlook on 18 European banks. "European banks were the Fitch focus, but naturally the sector is ... linked," Basi said.

The UK benchmark was down 35.67 points, or 0.5 percent, at 6,569.63 points by 0856 GMT, after closing flat in percentage terms on Wednesday. The index, up around 1 percent since a March 20 low, is some 4 percent below a 2014 peak.

Tensions between the West and Russia also weighed on the market. The United States and the European Union agreed on Wednesday to work together to prepare tougher potential sanctions in response to Russia's intervention in Ukraine, including sanctions on the energy sector.

"My sense at the moment is that investors have become very news-sensitive and it is not the possibility of an escalation in the Ukraine/Crimea conflict that is worrying them most, but the possibility that deep sanctions could derail the global economic recovery," Bill McNamara, an analyst at Charles Stanley (LSE: CAY.L - news) , said.

"The recent closing low, at 6,520, must now be seen as critical support." (Editing by Larry King)