By Anna Isaac and Caitlin Ostroff 

Signs of optimism that the U.K. could reach a divorce deal with the European Union drove the pound and stocks U.K. banks and home builders sharply higher Friday.

Sterling climbed 1.7% against the U.S. dollar on talk of a breakthrough between the two sides after months of worsening relations, causing investors to review their bets on the currency losing further value.

The currency posted its biggest-two day gain since December 2008, having climbed nearly 3.9%.

Shares in U.K. banks and home builders soared more than 10% on hopes a deal could avert further weakening in the British economy. Domestically focused Royal Bank of Scotland Group PLC, Lloyds Banking Group PLC and CYBG PLC are seen as bellwethers for the economy and have moved in tandem with sterling this year as a potential deal slipped in and out of view. Home builders Persimmon PLC and Taylor-Wimpey PLC, as well as construction-materials firm Travis Perkins, also rallied hard.

Investors attributed the sharp rise to remarks from European Council President Donald Tusk that he sees, for the first time, "a pathway to a deal." That followed a meeting Thursday between U.K. Prime Minister Johnson and Irish Prime Minister Leo Varadkar, where the two discussed how to unblock Brexit negotiations following a diplomatic impasse over avoiding a hard border appearing on the island of Ireland after Brexit.

"It's obvious that something in that meeting unlocked the situation," said Derek Halpenny, head of global markets research for Europe at MUFG Bank. "Something meaningful" had clearly been accomplished in that meeting, he said.

There are still hurdles to be overcome in the Brexit process for a deal to be sealed before the Oct. 31 deadline, analysts said, even as diplomats and other officials said talks would step up over the weekend.

A Brexit deal is now more likely to be passed by Parliament because key euroskeptic lawmakers believe Mr. Johnson will pursue a looser long-term relationship with the EU than his predecessor Theresa May, said Jordan Rochester, currency strategist at Nomura Bank.

While the pound climbed on the signs of a breakthrough, it is unlikely to return to the strength seen before 2016's EU referendum. The currency has fallen close to 17% against the dollar since the vote, and the greenback has gained in strength.

"Looking at the longer-term picture, we are still very much in the range for sterling that we've been in for the three-year period," said John Wraith, head of U.K. rates strategy at UBS Group AG.

UBS expects the pound to remain in a range from $1.05 to $1.50 in scenarios ranging from a hard Brexit to a new referendum in which the U.K. remains in the EU.

"Most likely is this, what we're calling the middle ground, where we sort of limp around with one extension after the other, or we then get a deal that sees the U.K. go into transition," Mr. Wraith said.

UBS recommends that clients stay light on risk for the pound and buy put options, a type of insurance against sudden price moves, for the euro against the dollar, as the bank expects that currency pair to react to future Brexit headwinds.

Among the banks, Barclays PLC, which also has a large U.S. credit cards business and investment bank, rose 6.8%.

The banking stocks have also been whipped around in recent weeks as investors fretted about how they might fare under a Labour government -- if Mr. Johnson doesn't reach a deal and the opposition party were to win a general election. Lloyds, RBS and CYBG are all still around 10% lower than in April, when an agreed delay to the planned exit from the European Union eased fears at the time of a no-deal Brexit.

John Cronin, a banks analyst at Goodbody Stockbrokers, said there was still "massive value" in banks after previous selloffs, "if you share my view that a compromise will be reached."

Paul J. Davies and Margot Patrick contributed to this article.

Write to Anna Isaac at anna.isaac@wsj.com and Caitlin Ostroff at caitlin.ostroff@wsj.com

 

(END) Dow Jones Newswires

October 11, 2019 10:59 ET (14:59 GMT)

Copyright (c) 2019 Dow Jones & Company, Inc.
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