By Huw Jones and Estelle Shirbon
LONDON (Reuters) - Banks based in Britain will lose access to EU markets after Brexit unless the country remains in the broader European trading group that includes nations such as Norway, the head of Germany's Bundesbank warned on Monday.
Jens Weidmann, signaling a tough line from Germany on the Brexit divorce talks to come, said Britain would need to be in the European Economic Area (EEA) to keep the so-called passporting rights that allow its banks sell their services across the European Union.
The EEA is the trading club comprising the 28 EU states plus Norway, Iceland and Liechtenstein, three non-EU nations who can access the bloc's single market in return for applying its rules and accepting the free movement of EU citizens.
"Passporting rights are tied to the single market and would automatically cease to apply if Great Britain is no longer at least part of the European Economic Area," German central bank chief Weidmann, who is also on the governing council of the European Central Bank, said in Britain's Guardian newspaper.
However joining the EEA and accepting free movement of EU citizens would be politically difficult for Britain. Its government has pledged to execute Brexit following a vote to leave the European Union that was driven in part by a desire to curb immigration.
Passporting rights are considered to be an important factor underpinning London's position as a global financial center. Losing them would be a blow for a financial services industry that generates about 12 percent of national economic output.
British Prime Minister Theresa May has said she will not trigger Article 50 of the EU Treaty to start formal divorce talks with Brussels before the end of this year, a step that starts a two-year countdown to actual exit.
Much of the negotiations, when they come, are likely to boil down to a trade-off between Britain's controls on immigration and its access to the EU single market.
May faces pressure from some in her government for a "hard" Brexit - or pulling out of the single market and an end to full passporting rights and the free movement of EU citizens - which makes EEA membership a non-starter.
Others, such as her finance minister Philip Hammond, as well as the banks themselves want to maintain access to the single market in some form.
Bundesbank head Weidmann said he expected some London-based businesses to reconsider the location of their headquarters after Brexit, but he did not see that turning into a mass movement.
"As a significant financial center and the seat of important regulatory and supervisory bodies, Frankfurt is attractive and will welcome newcomers. But I don't expect a mass exodus from London to Frankfurt," he said.
Banks in Britain are the largest borrowers and lenders of euros outside the single currency area, data from the Bank for International Settlements showed at the weekend, underlining how much is at stake for Britain's financial industry if its lenders fail to maintain access to EU markets.
Brussels has said that UK access to the single market would only be in return for continued free movement of EU citizens to Britain.
"We would reject cherry-picking. You cannot just pick out all of the best items and have just what suits you," European Commission President Jean-Claude Junker said at the weekend.
His officials will negotiate new trading terms with Britain and the talks must "lead to a result where it is clear that it is worth being a member of the EU", he said.
His comments signal a desire to show Britain that quitting the EU must bring some pain, seen as helping to deter other countries that might seek to leave.
(Editing by Kate Holton and Pravin Char)