ZURICH (Reuters) - The Swiss National Bank announced a shock cut in interest rates and threatened more action to cap a soaring Swiss franc, but was seen fighting a losing battle as investors seek respite from debt crises elsewhere.
The SNB said on Wednesday it would cut its target rate to "as close to zero as possible" from an already rock-bottom 0.25 percent, and said it would very significantly increase the supply of francs to the money market over the next few days.
It said it would not tolerate the effective tightening of monetary conditions imposed by what it called a "massively overvalued" franc which was threatening economic growth and increasing downside risks to price stability.
"The SNB is keeping a close watch on developments on the foreign exchange market and will take further measures against the strength of the Swiss franc if necessary," the bank said.
The euro shot up in response, gaining 2.5 percent on the day versus its Swiss counterpart after hitting a new record low before the SNB news. The dollar also rose sharply. But analysts said that trend could prove temporary.
"These measures will probably not bring a halt to the Swiss franc's appreciation," said Neil Mellor, currency strategist at Bank of New York Mellon. "It will be a hard fought battle for the SNB and at most this will slow the pace of appreciation."
With low-debt Switzerland seen as a safe haven from an escalating euro zone debt crisis and fears of a U.S. rating downgrade, the franc has surged 18 percent against the euro and 22 percent against the dollar in recent months.
The SNB is the first central bank to cut rates since the global economic outlook deteriorated with expectations for higher rates from the European Central Bank and U.S. Federal Reserve pushed back since signs emerged of a new slowdown.
"It's a very difficult situation for them with the ongoing issues in the periphery in Europe. The Swiss franc is a sort of default option here," said Henrik Gullberg of Deutsche Bank.
"That is unlikely to go away as long as we have these issues in Europe.
SWISS EXPORTERS SQUEEZED
Swiss exporters have called on both the SNB and the government to take action against its steep rise although the bank has also been criticized for the heavy losses it incurred in its post-crisis interventions in 2009 and 2010.
Nick Hayek, chief executive of watch maker Swatch, who has been one of the most outspoken about the impact of the strong franc, welcomed the SNB move. "This is wonderful. Speculators should brace themselves," he told Reuters.
In contrast to a fall on most European markets, the Swiss blue-chip index was up 0.6 percent after the SNB news.
The SNB said in a statement the global economic outlook had worsened since its last monetary policy meeting in June, while the sharp rise in the franc meant the outlook for the Swiss economy had "deteriorated substantially."
The euro was up 2.5 percent to 1.1116 at 0918 GMT after hitting a record low of 1.0794 on trading platform EBS before the SNB comments. The dollar rose to 0.7764 franc from around 0.7630.
After the Swiss franc rose about 12 percent against the euro in July alone, economists began to warn that a recession could be looming in Switzerland with forward-looking indicators such as the KOF economic barometer pointing to a slowdown.
The strong franc has also begun to hit the manufacturing sector, data for July showed on Tuesday.
Analysts said the SNB could resume the foreign exchange interventions it stopped in June 2010, even though its previous attempts were seen by many as an expensive failure.
"Maybe the threat of intervention will force people to look for other potential safe havens," said Lloyds Banking Group currency strategist Adrian Schmidt.
The SNB announced last week it suffered a 9.9 billion Swiss franc ($12.8 billion) first-half loss on its foreign exchange holdings due to the surging franc, increasing criticism of Chairman Philipp Hildebrand and making interventions politically more difficult.
Christoph Blocher, a leading figure in the right-wing Swiss People's Party, who has already called on Hildebrand to quit, launched a new attack on Sunday, saying the SNB boss behaved like a speculator and was not qualified for the job.
Before the big franc jump, Swiss interest rate futures had priced in the possibility of a first post-crisis rate hike for September, but Wednesday's news pushed back expectations for a rise in the rate target to 0.5 percent to June 2013.
To increase liquidity to the franc money market, the SNB also said it would expand banks' sight deposits at the SNB and would no longer renew repos and SNB bills that fall due and will repurchase outstanding SNB bills.
(Writing by Emma Thomasson and Catherine Bosley; editing by Mike Peacock, Ron Askew)