By Julien Ponthus and Helen Reid
LONDON (Reuters) - A breakthrough in Brexit talks helped British shares surge ahead of European peers on Friday as sterling fell back, dented by investors banking their gains in the currency which has swung violently as negotiations unfolded.
The blue chip FTSE 100 index closed up 1.2 percent, delivering its strongest week in two months, while euro zone stocks ended the day 0.7 percent higher with all sectors trading in positive territory.
Britain and the European Union struck a divorce deal paving the way for talks on future trade ties, easing immediate pressure on Prime Minister Theresa May and boosting hopes of an orderly Brexit.
The pound initially rose against the dollar, but profit taking and remaining doubts on the end-game of Brexit dented sterling which slid about 0.7 percent in afternoon trading.
"I think we've seen a classic case of the rumour being bought and the fact sold, with sterling having rallied early last week in anticipation of a deal being close," said OANDA analyst Craig Erlam.
Richard Stone, CEO of online trading platform Share, argued that sterling's immediate impact on shares should not eclipse the fact that the deal constituted "good news" for the British economy in the long run.
Falls in sterling generally support the FTSE as the weaker currency translates into an accounting boost for large firms with overseas revenues.
Financials drove most of the FTSE's gains after new global banking regulations, seen as kinder to European banks than feared, were adopted.
"This is a big positive for all European banks which should now be able to quantify excess capital and M&A budgets in due course", said Citi analysts in a note.
Lloyds rose 3.8 percent, leading gains as the domestically-exposed bank also benefited from Brexit relief, while Barclays gained 2.5 percent and HSBC 1.2 percent.
Housebuilder Berkeley was the top gainer of the index, surging 8.4 percent, after it announced a 36 percent rise in first half profits.
"The strong cash generation likely means year end net cash will be materially above consensus expectations of about 400 million pounds," UBS analysts said, adding the group had the options of "acquiring land as opportunities arise or returning more cash to shareholders".
Other UK builders, which have suffered on fears Brexit would hurt the sector, also rose.
Barratt Developments jumped 3.9 percent while Persimmon and Taylor Wimpey rose 2.3 to 2.8 percent.
Real estate investment trusts, also considered highly vulnerable to a messy Brexit deal, were among the best-performing. Hammerson and Land Securities Group gained 2.2 to 3.6 percent.
(Reporting by Julien Ponthus; Editing by Georgina Prodhan and Alison Williams)