In what experts called a last-ditch 'nuclear option', the Swiss National Bank (SNB) set a ceiling Tuesday on the value of its currency, which has skyrocketed this year as traders worldwide frantically searched for a safe haven in volatile times.
Aiming to protect Swiss exports and the country's vital tourism industry, the bank said it would spend whatever it takes to keep the Swiss franc from strengthening beyond 1.20 francs per euro.
It also indicated it might take more measures to weaken it further.
Philipp Hildebrand, chair of the central bank's governing board, said that the move to counter "a massive overvaluation of our national currency" was taken to avert a recession.
"Switzerland is a small and very open economy. Every second franc is earned abroad. A massive overvaluation carries the risk of a recession as well as deflationary developments," he said in a statement, adding that the goal is "a substantial and sustained weakening of the Swiss franc".
The reaction in markets was immediate. The euro, which had been trading around 1.10 francs before the announcement, shot up to 1.2024 afterwards. The dollar jumped from 0.7850 francs to 0.850 francs.
The Swiss stock market cheered the move, with the main index jumping 4.7 per cent.
But the central bank acknowledged the move could cost it large sums of money because it would be burning cash by buying foreign currency.
"With today's decision, the SNB sets foot on a challenging journey," Hildebrand said. "We have to accept the fact that the costs associated with it might be very high. At the same time, doing nothing would almost certainly inflict tremendous long-term damage on our economy."
Switzerland's status as a global safe haven for traders has seen the Swiss franc rally this year by as much as 40 per cent against the dollar and 30 per cent against the euro.
Tuesday's move was the first time since 1978 that the Swiss authorities have limited the franc's value in this way against another currency.
Hildebrand said the central bank would "no longer tolerate" an exchange rate below the minimum of 1.20 francs per euro and would "enforce this minimum rate with the utmost determination. It is prepared to purchase foreign (currency) in unlimited quantities."
But he said even the rate of 1.20 francs per euro was too strong for the franc and the bank believed it "should continue to weaken over time." He said if the economic outlook and deflationary risks demand it, the central bank was prepared to take further measures to make that happen.
The Swiss business federation welcomed the SNB's decision, but indicated its members would like the franc to drop even further against the euro.
"We believe a fair rate to be between 1.30 and 1.40 francs, but this is a good compromise between what's needed and what can be done," board member Rudolf Minsch said.