The two sides have reached 'complete agreement' on citizens rights and the divorce bill, but the Irish border continues to remain unsolved.
The deal means the UK will be able to negotiate trade deals during the period - which will run until 31 December 2020 - but remain part of the Single Market and customs union. The UK will also therefore be bound by EU rules but will not have a say on any decision-making.
Davis said the breakthrough would give businesses much-needed clarity, and it received a qualified thumbs up from industry groups.
Adam Marshall, director general of the British Chambers of Commerce, said: 'This is a milestone that many businesses across the UK have been waiting for. The agreement of a status quo transition period is great news for trading firms on both sides of the Channel, as it means that they will face little or no change in day-to-day business in the short term.
“While some companies would have liked to see copper-bottomed legal guarantees around the transition, the political agreement reached in Brussels is sufficient for most businesses to plan ahead with a greater degree of confidence. Many companies will now have the clarity they require to proceed with investment and hiring strategies that would otherwise have remained in question.'
He urged the EU27 not to turn transition into a 'political football', and said both sides must 'adopt a laser-like focus on the future trading relationship – and swiftly conclude a deal that minimises further adjustment costs and that answers the many practical questions that trading businesses still face'.
In the City, the chief executive of the Association for Financial Markets in Europe (AFME) Simon Lewis, said transition was 'a major step forward'.
'We look forward to seeing more details at the EU summit later this week,' he added. 'While this agreement is a big move in the right direction, it will be important to see that there is real political and regulatory commitment from both sides to a transition period.”
Policy Chairman of the City of London Corporation, Catherine McGuinness, added: 'Today’s announcement lifts some weight off the shoulders of firms in the UK and the EU. Before the announcement firms were peering over the precipice. They are now on firmer ground and we hope that the regulators will be tasked to work together by the UK and EU to underpin this political commitment and give firms the certainty they need.
“But there are still a number of areas to be resolved – notably the Ireland and UK border issue. Government has made great progress in recent weeks. It’s vital we find a resolution to this issue as soon as possible.”
Allie Renison, head of Europe and trade policy at the Institute of Directors, said: 'Business leaders will welcome the announcement of a provisional agreement on an implementation period and congratulate the UK government for heeding the call of business and making it a priority early on. Knowing that trade and immigration arrangements will continue unchanged until at least the end of 2020 will allow business operations and investment decisions to carry on without unnecessary disruption for the time being.
“We are, however, concerned that not enough attention is being given now to the finer details and practical implications of transition. Many businesses will only be able to sufficiently plan and prepare for Brexit once the precise details of the future relationship are known, and any changes to domestic infrastructure like customs have been implemented.'