iPhoto doesn't change the location (that is, the GPS coordinates that are part of the photo's EXIF data), it may assign a different label to those coordinates than your camera-maker did, but it hasn't changed the GPS coordinates recorded in the EXIF data.
The difference between your camera's location tagging and iPhoto's is how the designers have chosen to use map data. When you view one photo in the viewfinder of your camera, the GPS location tagging can be very precise. When you start covering a map with pins, clutter and over-precision becomes a consideration.
Consider the behavior of the map in iPhoto. When you zoom out, closely-spaced locations are merged into a single pin, with a regional name. When you zoom in, those pins start to separate into multiple pins. Even if every pin within the bounds of London is labeled "London," the actual location of the pins is visible on the map, and you can view photos taken in that specific pin location. You should have one or more pins located in Trafalgar Square. You can change the location tag for that pin, so if the pin's tag says, "London," you can re-label the pin "Trafalgar Square." See iPhoto Help > View and organize > By location > Change place names
One possible explanation of Apple's choice is that each differently-named tag is separately listed in the Places drop-down list on the map. If iPhoto tagged each pin with precise coordinates, such as "34th St. and 8th Ave., New York City," the Places list would get very long, very fast. Apple has decided to group all photos within a certain radius with a single pin, and to treat only some locations as unique places within a city's boundary. We can quibble with their decisions, and the good part is, if Apple changes their mind, a software update fixes it.
I haven't been to London with a GPS-capable camera (or iPhone, for that matter), so I don't know how iPhoto is handling map data for that city. However, I decided to zoom in on Halifax, Nova Scotia, where I did a fair amount of shooting with my iPhone. When zoomed to maximum, I see 7 pins just within the bounds of the Public Gardens. All those pins are tagged "Public Gardens," though each pin links to different photos. I have additional pins scattered around town, all of which are tagged "Halifax." If I click the tag, however, it shows only those photos taken in that particular pin location (such as the intersection of Queen St. and Sackville St.). I might start re-labeling some of those "Halifax" pins with greater precision, but in my case, I haven't found the need.