"The Russian president remarked that the sharp escalation of the conflict has placed the country, in effect, on the verge of civil war," the Kremlin said in a statement on telephone talks between Putin and German Chancellor Angela Merkel.
But the leaders both "emphasised the importance" of planned four-way talks on Ukraine on Thursday between top diplomats of Russia, the European Union, the United States and Ukraine.
Ukraine pushed tanks towards a flashpoint eastern city on Tuesday to quash a separatist surge backed by Moscow -- a high-risk operation that was sharply condemned by the Kremlin but won Washington's support.
The 20 tanks and armoured personnel carriers sent to Slavyansk were the most forceful response yet by the Western-backed government in Kiev to the pro-Kremlin militants' occupation of state buildings in nearly 10 cities across Ukraine's rust belt.
"They must be warned that if they do not lay down their arms, they will be destroyed," Ukrainian Security Service (SBU) General Vasyl Krutov told a group of reporters tracking the sudden tank movements.
- 'Untenable' situation -
He insisted that the militants were receiving support from several hundred soldiers from the Russian army's Main Intelligence Directorate (GRU) that had been dispatched to Slavyansk and surrounding villages.
The economically depressed industrial city of 100,000 has effectively been under the control of separatist gunmen since Saturday.
Ukrainian troops were also helicoptered into a military aerodrome at Kramatorsk, south of Slavyansk which the interior ministry said was "liberated" without any casualties.
However pro-Russia activist Oleg Issanka told AFP that the troops had opened fire injuring two people.
The Kremlin statement described the actions of the Ukrainian army in eastern Ukraine as an "anti-constitutional course to use force against peaceful protest actions".
Kiev's response to the eastern insurgency prompted Putin to tell UN Secretary General Ban Ki-moon that Moscow "expects clear condemnation from the United Nations and the international community of the anti-constitutional actions" by Ukraine.
Ban in turn "expressed his alarm about the highly volatile situation in eastern Ukraine" and told the Russian leader that everyone involved needed to "work to de-escalate the situation", his office said.
But the White House described Ukraine's military operation as a "measured" response to a lawless insurgency that had put the government in an "untenable" situation.
The threat of all-out war breaking out just beyond the European Union's eastern frontier sent stock markets across Europe tumbling on Tuesday.
"New fears about Ukraine worried the market and could, at any time, send it plunging once again," said Saxo Bank analyst Andrea Tueni.
- 'Frank' Putin-Obama talks -
The rapid turn of events on the ground was preceded by a telephone conversation Monday between US President Barack Obama and Putin that the White House described as "frank and direct".
The Kremlin chief continued to reject any links to the Russian-speaking gunmen who have proclaimed the creation of their own independent republic and asked Putin to send in the 40,000 troops now massed along Russia's border with Ukraine.
But Obama accused Moscow of supporting "armed pro-Russian separatists who threaten to undermine and destabilise the government of Ukraine".
The worst East-West standoff since the Cold War was exacerbated over the weekend by a Russian warplane "buzzing" a US destroyer in the Black Sea and a visit to Kiev by CIA chief John Brennan that was confirmed by the White House and condemned by Moscow.
The US meanwhile said it was coordinating with its European allies to slap more sanctions on Russia over the crisis.
"Our national security team is in active discussions about the next round of sanctions," State Department spokeswoman Jen Psaki told reporters.
She added however that new measures were unlikely before the highly anticipated EU-US mediated talks on Thursday in Geneva between Moscow and Kiev.
- Southeast 'on fire' -
Kiev's untested interim leaders -- who took power after four months of pro-European protests ousted Kremlin-backed president Viktor Yanukovych in February -- have struggled to meet the high-stakes challenge presented by the coordinated series of raids that began in the industrial hubs of Donetsk and Lugansk and have since spread to nearby coal mining towns and villages.
The breakaway move could potentially see their vast nation of 46 million people break up along its historic Russian-Ukrainian cultural divide.
Moscow last month annexed the largely Russified region of Crimea after deploying military forces there and backing a hasty local referendum calling for the Black Sea peninsula to be absorbed into the Russian Federation.
But a forceful military response by Kiev could prompt a devastating counterstrike by Russian troops who are waiting to act on Putin's vow to "protect" Russian-speakers in the neighbouring state.
Ukraine's acting President Oleksandr Turchynov told an agitated session of parliament that the country was facing an eastern enemy rather than domestic discontent.
"They want to set fire not only to the Donetsk region but to the entire south and east -- from Kharkiv to the Odessa region," the acting president said.
The Kremlin set nerves in Kiev further on edge on Monday by announcing Putin had received requests from eastern Ukraine "to intervene in some form". Some in Kiev saw that as a new effort to create a pretext for an invasion.