(Adds expected news conference)
* Davis, Barnier to update on progress on Thursday
* Hammond, Tusk stress need to talk transition soon
* Businesses want certainty by early in new year
* Tight schedule means EU sees few options for transition
* Either UK keeps virtual status quo or has "hard Brexit"
By Alastair Macdonald, Gabriela Baczynska and Jan Strupczewski
BRUSSELS, Oct 12 (Reuters) - Nerves are fraying in the Brexit talks, negotiators are trying to work out if the other side is bluffing about walking away, and a ticking clock is fast narrowing British options come March 2019.
Philip Hammond, Britain's finance minister, echoed recent EU assertions when he said that a transition period to some new relationship was a "wasting asset", the value of which would "diminish significantly" for both sides if its form remains unclear to businesses much after the start of the new year.
As negotiators in Brussels make little progress before Prime Minister Theresa May meets EU leaders next week, a warning about a breakdown in talks from a minister seen strongly to favour a business-friendly "bespoke" transition out of the EU came a day after the EU summit chair spoke of a similar new year deadline.
Donald Tusk said on Tuesday that if London fails to settle divorce terms by December, and so unlock talks on the transition and future trade pact, then the EU would reconsider its objectives. That reflects mounting doubts across Europe that any legal exit deal can be struck.
The longer the stand-off goes on, EU negotiators said, the more Britain's choice come March 30, 2019, will be between the "hard Brexit" by which it will simply quit all EU systems and be treated like, say, Australia, and a virtual status quo, staying in most EU systems, without voting rights, rather like Norway.
"The closer we get, the less there is to discuss about a transition and the more it just goes to a standstill transition, with Britain still in everything, but without a vote," one said.
"Pretty soon," said another, "It will be Norway or nothing."
While all such commentary reflects the sides' jockeying for negotiating advantage, the evidence this week is that they remain far apart and are getting tetchy. May and the EU traded jabs over whose court "the ball" is in after the prime minister made concessions in a speech at Florence on Sept. 22.
Behind closed doors, British negotiators voiced outraged surprise that her offer was seen as insufficient to launch talks on the future relationship. "It's hard to say it was genuine," one EU official said of the show of emotion. "It's a form of pressure."