LONDON (Reuters) -Britain's stock market finally appears to be reversing years of underperformance against the rest of Europe, as a UK/U.S. trade deal, lighter regulation and cheap stocks deliver juicy returns that are starting to attract foreign investors.

The FTSE 100 has gained nearly 10% this year to hit record highs this week, beating the STOXX 600, which is up 7.5%.

On a year-to-date basis, London's blue-chip index has performed better than its European counterpart for the last six weeks, its longest such stretch since late 2022, when a weak pound beefed up revenues for the export-focused FTSE.

This week, the financial regulator said it will roll out new rules to boost Britain's capital markets, while Chancellor Rachel Reeves told the financial industry to paint a less negative picture of UK stocks for would-be retail investors, as she seeks new ways to revive a stagnating economy.

For foreign investors, the blue-chip index is already looking appealing given sterling's rally this year, while asset managers say the narrative around the UK is shifting.

"We are seeing signs of big asset allocators coming back to the UK," Justin Onuekwusi, chief investment officer at St. James's Place. "I am talking about non-UK endowments, pension funds, asset owners, wealth managers who were all very underweight the UK post-Brexit," he said.

In dollar terms, the FTSE-100 is up nearly 18% so far this year, set for the biggest dollar-denominated returns since 2009, compared with a 6% year-to-date gain in the S&P 500, which has also hit record highs.

The pound, up 7% this year against the dollar as investors turn away from U.S. assets in response to heightened U.S. policy uncertainty under U.S. President Donald Trump, acts as a headwind for FTSE constituents, 80% of whom get their revenues from overseas.

Yet the index's wealth of large defensive companies, including healthcare, utilities and food retailers, help insulate it against swings in the underlying economy, like drugmaker AstraZeneca or supermarket chain Tesco

It also has growth-sensitive resource stocks such as Anglo American and BP to tap into strength in oil, copper and gold.

Britain meanwhile is one of the few economies facing less trade uncertainty with a U.S. trade deal in place. In contrast, the European Union faces the threat of 30% tariffs if there is no agreement by August 1.

'TEA AND BISCUIT'

"The UK stock market is the calming cup of tea and biscuit in an uncertain world. There's nothing fancy on offer, just reliable names that do their job day in, day out," AJ Bell investment analyst Dan Coatsworth said.

Valuations for FTSE-100 companies have lagged those elsewhere in Europe for years.

The 2016 Brexit vote accelerated that trend, with fewer companies using London to list their shares and fewer cropping up as M&A targets, given the political and economic uncertainty that prevailed at the time.

Now the UK market is catching up. The FTSE-100's 12-month forward price-to-earnings ratio of 12.5 is the highest for around five years, compared with 14.11 for the STOXX, the narrowest gap in around 18 months, LSEG data shows.

The S&P trades at a ratio of 23, a near-10 point premium to the FTSE, compared with under 2 points 10 years ago.

"The relatively poor performance we've seen in the UK versus particularly the U.S. over the past two years has begun to unwind. We're in the foothills of that," Michael Stiasny, head of UK Equities, M&G Investments, said, adding that the UK market has traded at a "significant discount".

The pound is close to a four-year high against the dollar, but has weakened against the euro this year, offering a tailwind to the FTSE's big exporters.

The EU is Britain's largest trading partner, accounting for 41% of exports in 2024, followed by the United States, with 22%, according to official data.

It isn't all rosy. The British economy is flagging, inflation is well above the Bank of England's target of 2% and business activity and employment are slowing.

Barclays data shows UK equities have seen a net outflow of $20 billion in 2025, although outflows have almost dried up in the last month, compared with Europe's year-to-date inflow of $13 billion and rapidly slowing inflows.

Sebastian Raedler, head of European equity strategy and Bank of America Merrill Lynch, said he felt the FTSE's strong run was a function of the currency and in line with the rest of Europe.

"Net-net, the FTSE has mildly outperformed, but I would say in an environment where there are a lot of big stories ... a 2% (out)performance of the UK this year would rank further down the radar from my perspective," he said, referring to the percentage gain in the FTSE in 2025 versus that of the STOXX.