Al, not yet illegal unless the CAA issue a direction to you, declining to accept your FAA ticket as valid because of the class 3 medical. If they are really concerned about the medical, I don't know why they don't just say "FAA OK, but make sure you have a JAA class 2 medical as well", which on your scenario would cause you no difficulties. Also, Al, the problems that may arise appear to relate to using the FAA licence on a G reg aircraft, not an N reg.
If I recall correctly (although I have not loooked it up: the ICAO website is fogbound at present and my copy of Beaumont and Fletcher has been hijacked*), the Chicago Convention permits ICAO member states to set their own validation requirements in respect of licences issued by other member states [see edit below]. If I can look this up later, I shall let you know what I find.
Edit: ICAO still foggy, but the McGill University website is CAVOK, allowing a check on Art 32 of the Convention, under which member states reserve the right not to recognise licences granted to their own nationals by other member states. Art 32 deals with trans-national validation requirements, under which ICAO agrees on minimum validation standards, which can change from time to time.
http://www.iasl.mcgill.ca/airlaw/index.htm
If a State were to cease to recognise a licence which it had formerly recognised, arguments might concievably arise based on the public law concept of legitimate expectation, but here we are getting into the realm of specific individual circumstances, in respect of which a discussion forum cannot provide a substitute for individual advice.
* Beaumont and
who? See Heliport's message on the next page: it appears that my brain has also been hijacked.