LONDON, July 12 (Reuters) - It started as a local dispute over China's plans to build a new embassy next to the Tower of London - pitting the world's second biggest superpower against an inner-city borough that blocked the project.
Just over seven months later, it is escalating into a diplomatic standoff that, officials from both countries told Reuters, is undermining efforts to repair their badly damaged relations.
Two Chinese and three British officials told Reuters the Chinese government had expressed its frustration over the failure to grant planning permission for its embassy at official-level meetings.
That has led officials in Britain, which is trying to forge deeper economic ties post-Brexit, to fear it could also halt their own plans to rebuild its embassy in Beijing. Space is already running short on the existing cramped site. One visitor said a squash court had to be turned into a office.
The officials say the embassy spat has undermined attempts by British Prime Minister Rishi Sunak to forge a new approach to China, one which would balance London's national security interests with better cooperation on trade and climate change.
It is a far cry from 2015 when former Prime Minister David Cameron and President Xi Jinping shared beer and fish and chips at an English village pub and declared a "golden era" for London-Beijing relations.
China first announced plans in 2018 for a 700,000-square-foot embassy on the former site of Britain's the Royal Mint - the official maker of British coins - its biggest mission in Europe, almost twice the size of its one in Washington.
It bought the land - around 4 miles from its current base in central London - for about 255 million pounds ($311 million). But while unelected planning officers accepted the proposal, local elected councillors overruled them, rejecting it on security grounds and the impact on residents.
Chinese officials told Reuters they suspected the British government had plotted to stop the embassy plans and orchestrated the local opposition.
They have raised their unhappiness about being unable to relocate to the new site in meetings with British counterparts in recent months, according to four people involved or with knowledge of the talks. Reuters could not determine in exactly how many meetings the issue had been raised.
"It is definitely political," one Chinese official said.
British officials - caught between the demands of Beijing, politicians and some equally vocal local residents - have dismissed those accusations, saying councils make their own decisions.
The stakes are high - China has been the second-largest source of foreign direct investment into London for the last decade, behind the United States.
"It is very messy and a headache we could do without," one British official said. Britain's housing and foreign ministries declined to comment.
DEADLINE LOOMING
The British government has been keen to distance itself from the whole planning process. But it will most probably need to pick a side soon.
An Aug. 11 deadline looms for Beijing to appeal against the planning refusal.
The first step in any such appeal would require an application to an independent Planning Inspectorate reviewer.
If the Planning Inspectorate finds the application contentious or nationally significant it would go to British housing minister Michael Gove, who could also "call in" the project if he wants to take the final decision himself.
And that is when it gets more difficult.
Concerns about the crackdown on freedoms in Hong Kong, reports of human rights abuses against the Uyghur people in Xinjiang, and suspicion over China trying to penetrate security systems have all intervened. Beijing has denied all the charges.
There have been no leader-level face-to-face meetings since 2018. Planned talks between Sunak and Xi on the sidelines of a global summit in November last year were abruptly cancelled. The last telephone call between the nations' leaders came more than a year ago.
Like other European states, Sunak's government has adopted a policy of seeking to neutralise security threats posed by China - notably by banning some Chinese technology — while seeking to engage in areas such as trade, investment and climate change.
Iain Duncan Smith, a former leader of Sunak's governing Conservative Party, wants it to go further, saying a decision to block the embassy would show how Britain prioritises national security in its relationship with China.
The government's approach to China "is all very mushy. We need to be able to say we are not prepared to kow-tow", he told Reuters.
'OUT OF OUR HANDS'
The Chinese foreign ministry in a statement to Reuters last month urged the British government to meet its "international obligation" to help it build a new embassy and said China wants to find a solution "on the basis of reciprocity and mutual benefit".
British officials, who declined to be identified, said they feared that London's plan to rebuild its embassy in Beijing would be affected.
An application had been submitted but permission had not yet been granted, one official said. It was not clear when the application was submitted.
Another official said they see the planning applications as two separate processes.
The officials spoke on the condition of anonymity, due to the sensitivity of the subject.
And then there are the people of Tower Hamlets to take into account.
During the original planning process, some residents from the area, which has a big Muslim population, raised what they said was China's persecution of the Uyghurs.
At one point, councillors wanted to hammer their point home by renaming local streets or new buildings Uyghur Court and Tiananmen Square - plans that were never adopted.
Residents say they are also worried about more local security issues.
About 300 of them live in flats that back onto the site. China became the freeholder of these properties when it purchased the land and is now, effectively, their landlord.
Dave Lake, the chair of the Royal Mint Court Residents Association that represents the home owners, said local opposition might decline if China promised never to enter the flats or take actions such as banning flags.
But his biggest concern now was that Britain and China would force through a deal, ignoring the locals.
"I feel hopeless. It is completely out of our hands and it doesn't sound good at all," he said. "Our security issues are that critical and that big, and I feel they could be overlooked."
Additional reporting by Martin Quin Pollard in Beijing. Editing by Kate Holton and Andrew Heavens
