The second breakthrough in just over a week in the Brexit talks process pushed sterling higher and weighed on shares in London that rely on a weak British currency.
The pound climbed 1% against the dollar and rose 0.5% to 88.5p against the euro.
The Ftse-100 index fell over 1.25% as shares of companies which generate most of their sales outside the UK fell back.
British prime minister Theresa May hailed another draft agreement struck with the EU yesterday, which agreed on an outline for UK-EU trade, security, and other issues after Brexit.
Last week, the EU-UK agreement on a transition deal and a backstop for the border was attacked by Brexiteers, her DUP political allies, the SNP, and UK Labour Party leaders, though business groups across Ireland and Britain had welcomed it.
Analysts said the sterling bounce may be shortlived, however, as Ms May prepares for the very uncertain outcome of the vote by the House of Commons on the transition deal next month.
“Britain and the EU have agreed in principle to a text setting out their future relationship that can be endorsed by EU leaders at a summit on Sunday. The deal sent the pound up as much as 1% on relief that prolonged and tense negotiations had shown progress,” said Joshua Mahony, market analyst at online broker IG.
“However, with neither the EU nor parliament having signalled that the proposal will pass, elevated risks remain.”
Fiona Cincotta, senior market analyst at City Index, said the transition agreement will face tough UK parliamentary tests soon.
“What is driving the pound is the ambitious tone of the declaration of future ties, which could help Theresa May secure sufficient backing when she tries to pass the Brexit package through parliament,” said Ms Cincotta.
“Following the relief rally, the pound came away from the highs reflecting the fact that the text whilst broad, contained less detail than traders would have liked to have seen.”
Against the dollar, the euro’s gains continued to be held back by concerns over the standoff between the European Commission and the Italian government over Rome’s budget spending plans.
In Frankfurt, the release of the minutes of the ECB meeting last week indicated it was on course to start ending its massive bond-buying programme at its next meeting in December.
The ECB believes the eurozone growth outlook was still showing an “ongoing broad-based expansion”. US stock markets were closed for Thanksgiving.