The deal covers the ten local authorities that make up the Cardiff Capital Region and will focus on upgrading transport links, skills, and employment and business support.
Governance will be provided through a Cardiff Capital Region Cabinet where the ten local authority leaders will make joint decisions and pool resources.
The £1.2bn includes £500m from the UK, £500m from the Welsh Government with a minimum of £120m coming from the ten local authorities.
Speaking on Tuesday, chancellor George Osborne said the deal was part of his “devolution revolution”, which include City Deals. Local leaders were best placed to take the decisions that will strengthen the Welsh economy and make it fit for the future, he added.
Welsh secretary Stephen Crabb said: “Cardiff is one of Europe’s youngest and most dynamic capital cities, with a growing international profile and a burgeoning reputation as a destination for businesses to invest.
“The City Deal provides the springboard for Cardiff to emerge as a leading engine of growth in the UK.”
Welsh first minister Carwyn Jones said the deal was a vote of confidence in the region and would be a “huge economic boost” for Wales.
“Central to the success of a City Deal is the close collaboration and partnership between all ten local authorities. It is a great example of what can be achieved by coming together for the greater good of our capital region,” Jones added.
Following the agreement, £1.2bn will be invested in the region’s infrastructure through a 20-year investment fund, out of which a priority project is the South East Wales Metro.
A Regional Transport Authority will also be created to co-ordinate regional transport and investment together with the Welsh Government. A region-wide skills and employment board will ensure training is responsive to the needs of employers and the community.
An element of welfare could also be devolved through the deal. The regional cabinet and Welsh Government will work with the Department for Work and Pensions to co-design future employment support for people with health conditions, disabilities and those who are long-term unemployed.
Local authorities have requested some further financial flexibilities. Among measures being considered by the Treasury are devolution of business rate income above an agreed growth baseline, powers to levy and infrastructure supplement and the use of alternative finance sources.
The ten local authorities included in the Cardiff Capital Region are: Cardiff, the Vale of Glamorgan, Rhondda Cynon Taff, Merthyr Tydfil, Caerphilly, Monmouthshire, Bridgend, Blaenau Gwent, Torfaen and Newport. All will need to formally ratify the deal.
In the Budget on Wednesday, Osborne announced that the government would opening discussions on a city deal for Swansea and a growth deal for North Wales, both of which had been called for by Jones.