Business Analysis: Now the City starts to calculate the cost of Europe's clothing mountains

As eight million Chinese-made dresses joined the growing European clothing mountains, the City of London began to count the financial cost of the deadlock between the European Union and China over textile imports.

In Beijing, talks aimed at clearing the backlog of 80 million garments stuck at customs points across Europe broke up without an agreement. They will resume again first thing this morning although sources close to the negotiations cautioned yesterday that a solution was not expected until the middle of next week.

With summer well and truly over in fashion terms, shops are desperate to roll out their autumn collections. Retailers, already anxious to recover from one of the worst years in recent memory, are all too aware that every military-style jacket that is sold at full price in September means one less item for the post-Christmas clearance sales.

But the EU's decision to halt imports of Chinese-made goods that breached the quota agreement rushed through at the end of June to deal with a flood of Chinese imports has put retailers in a bind. They are unable to get import licences for stock ordered at the beginning of July because the tight quotas were filled faster than any of the bureaucrats in the European Commission could ever have envisaged.

Trousers, pullovers, women's blouses, T-shirts and bras have all exceeded the limits set.

David Keens, the finance director of Next, said: "Having implemented these rules retrospectively, they have put us [the retail sector] in a very, very difficult position commercially. We ordered goods in good faith and then suddenly the politicians changed the rules of the game."

Investec Securities warned yesterday that the blockages in the supply chain posed a "threat to forecasts". The broker's retail analyst, Matthew McEachran, said retailers risked having as much as 5 per cent of their second-half profit wiped out by the impasse. For a sector that relies on the profit made over the all-important Christmas period, the timing of this crisis could not be worse.

"Given the long lead times and planning [when sourcing from China], to re-introduce quotas at such short notice at this time of year is beyond a joke for retailers. The problem is there are substantial volumes of product in every single nook and cranny of the supply chain," Mr McEachran said. "The market has either ignored the issue or chosen to downplay it but the reality is that it has got to the point where it is serious. Every week that ticks on has a knock on effect." The growing sense of drama was heightened by the admission by Peter Mandelson, the EU's Trade commissioner, that there had been a "serious glitch" in the implementation of the agreement, hitting sentiment towards some of the FTSE's biggest retailer stocks.

Although the UK's high street names have been careful to distance themselves from the crisis, fearful of giving shoppers the wrong impression, shares in Next, Marks & Spencer, Mothercare and Associated British Foods, which owns the discount retailer Primark, all fell. Next lost 19p to 1509p, while ABF slipped 9p to 845.5p.

Mr McEachran said: "Retailers don't want to send a message to the public that they are not providing choice or the right products." He calculates M&S as having the biggest exposure of the problem due to its 25 per cent share of the lingerie market. He listed risks as ranging from rising sourcing costs as demand soars in other countries, to product shortages given the long lead times required for some products.

He added: "Retailers may not be able to pass price increases on to the consumer given the tougher backdrop to spending [which would squeeze profit margins]. Finally, there will be a risk of heavy discounting if delayed stocks do get shipped to the UK but arrive late and fill the market with out-of-season stock."

So far, only Hennes & Mauritz, Europe's biggest clothing group, had confessed to having a problem - with pullovers, 48 million of which have been blocked entry into Europe. Paer Darj, the head of investor relations, said "eight days worth" of the retailer's jumper shipments were stuck due to the confusion over the original terms of the agreement announced on 10 June.

The so-called Shanghai agreement guaranteed all goods ordered until 12 July, when it became law, import licences. But problems arose because retailers continued to order goods after that date, unaware that the tight limits set on six clothing categories and four textile categories meant that some of the quotas had already been filled.

"Everything shipped from China before the 20 July [when the Chinese stopped issuing export licences] should be allowed in," Mr Darj argued. EuroCommerce, the European retail association, has called for all orders placed with Chinese textile producers before 12 July to be cleared for entry. The British Retail Consortium, which estimates that £550m-worth of goods are stuck, also supports that argument.

The Department of Trade and Industry said yesterday that the Commission was "well aware of the serious problem facing UK importers and retailers and of our wish for an urgent solution". As the UK holds the presidency of the EU, its representative is chairing the crisis team.

At today's meeting negotiators are expected to suggest remedies such as bringing forward quotas from next year, or swapping capacity between different categories. Quotas were imposed until the end of 2007 in response to complaints from countries with big textile industries, such as France, Italy and Portugal to give those industries time to adapt. Quite what those same manufacturers were doing during the 10 years earmarked for the phasing out of textile quotas, that ended on 31 December 2004 with the dissolution of the Multi-Fibre Agreement, is not clear, argue observers.

Given that in the first half of this year, China sold about $8bn (£4.5bn) worth of clothing to Europe - almost the same as in all of last year - its attraction to retailers was obviously long before Mr Mandelson's team sat down at the negotiating table in June.

Ben Rudd, Asia strategist at ABN Amro, said: "Bringing next year's quotas forward to this year buys some short-term breathing space but just puts off the problem until next year. The reality is European retailers are in a bind. You can't just suddenly move production of a particular dress to somewhere else."

Gary Titley, leader of the European Parliamentary Labour Party, said there was an additional worry for the UK, where aside from Scottish pullover knitters textiles is largely an ethnic minority industry. "Losing jobs in Indian, Pakistani and Bangladeshi communities is quite serious. Look what happened with the Gate Gourmet dispute with British Airways," he said. Many of the Sikh population living near Heathrow worked for both companies so the BA staff came out in support of their fellow community members.

With the US trying to conclude its own set of talks with the Chinese on textile quotas, it won't be only EU attention that is focused on Beijing over the weekend.