Ecuador is still willing to negotiate with the British government over the fate of Julian Assange, despite the Foreign Office's "threat" to arrest the WikiLeaks founder inside its embassy and the "intimidating" police presence in and around the building, according to a senior Ecuadorean diplomatic source.

The South American country's decision to grant political asylum to the 41-year-old Australian, who faces allegations of sexual assault in Sweden, has provoked a bitter political row between Quito and London.

The source complained that the UK government's written warning that it could use the Diplomatic and Consular Premises Act 1987 to arrest Assange inside the embassy had been accompanied by a large increase in the number of police officers at the Knightsbridge building.

The police presence, it added, had risen from two or three to around 50, with officers on the embassy's fire escape and at every window. This was described as "an absolutely intimidating and unprecedented use of police" designed to show the British government's desire to "go in with a strong hand".

However, the source said that Quito had been encouraged by a phone call made by the Foreign and Commonwealth Office to the Ecuadorean ambassador on Thursday. "The FCO called the ambassador yesterday to confirm that it still had the will to talk and negotiate, so we'll keep talking," it added.

"The fact that they called the ambassador makes us think that the letter with the threat of using domestic legislation to make an incursion into the embassy and arrest somebody inside was a mistake – as was the intimidating increase in the number of police surrounding the embassy on the same day the letter was delivered."

It stressed that Ecuador was willing to co-operate with the British and Swedish authorities over the matter of Assange's extradition to Sweden. "In the negotiations with the FCO, Ecuador has been proposing that we would be prepared to accept an undertaking from the UK and Sweden that, once Julian Assange has faced the Swedish investigation, he will not be extradited to a third country: specifically the US. That might be a way out of it and Ecuador has always said it does not want to interfere with the Swedish judicial process; we could facilitate it."

The source said the Ecuadorean government had been bolstered by the support it had received since deciding to grant asylum to Assange, adding: "We are moved by the overwhelming level of solidarity that Ecuador now has in the [Latin American] region."

Asked how Assange was coping with the pressure of life in the small embassy, where he has been living for 55 days, the source said: "He's fine. He's not stressed out. Given the fact that he has been under pressure for so long and that his legal fight has gone through so many different levels, I think that for his safety he always had a last resort."

Scotland Yard declined to comment on the policing operation at the embassy, while an FCO source said the letter sent to the Ecuadorean authorities on Wednesday was not menacing and that the rights of the country's officials would continue to be respected by the government.

"The letter was not a threat," said the source. "There had already been many meetings with the Ecuador government. It was just that it was quite clear that they were close to making a decision and we wanted them to know the law. It was merely signposting the fact."

The foreign secretary, William Hague, was informed about diplomatic developments on the Assange case, although a spokeswoman declined to divulge further details, saying: "We are not providing a running commentary."

At a press conference on Wednesday, Ecuador's foreign minister, Ricardo Patiño, released details of the contentious letter, which he said was delivered through a British embassy official in Quito.

The letter said: "You need to be aware that there is a legal base in the UK, the Diplomatic and Consular Premises Act 1987, that would allow us to take actions in order to arrest Mr Assange in the current premises of the embassy." It added: "We need to reiterate that we consider the continued use of the diplomatic premises in this way incompatible with the Vienna convention and unsustainable and we have made clear the serious implications that this has for our diplomatic relations."

Patiño said that Ecuador rejected the "explicit threat" made in the letter, adding: "This is unbecoming of a democratic, civilised and law-abiding state. If this conduct persists, Ecuador will take appropriate responses in accordance with international law. If the measures announced in the British official communication materialise they will be interpreted by Ecuador as a hostile and intolerable act and also as an attack on our sovereignty, which would require us to respond with greater diplomatic force."

Hague has denied suggestions that the FCO was threatening "to storm an embassy", saying: "We are talking about an act of parliament in this country which stresses that it must be used in full conformity with international law."

He has also said that Assange will not be allowed safe passage out of the UK despite the asylum decision, and that diplomatic immunity should not be used to harbour alleged criminals.

It is unclear whether Assange will address his supporters at the embassy on Sunday, as has been reported. He has described the granting of political asylum by Ecuador as a "significant and historic victory".