By Joice Alves and Julien Ponthus
LONDON (Reuters) -Switzerland's franc soared on Thursday after the Swiss National Bank took markets by surprise with a large interest rate hike, putting the currency on track for its biggest one-day rise against the euro in more than seven years.
The central bank had broadly been expected to stand pat on a -0.75% interest rate that was the lowest in any major developed country, though some banks had suggested a quarter-point was possible.
Instead, the SNB increased its policy rate to -0.25% from the -0.75% level it has deployed since 2015.
The hike was the first increase by the SNB since September 2007 and follows Wednesday's aggressive 75 bps rate increase from the U.S. Federal Reserve.
"It's telling of the general environment that even the previous doves are now worried about inflation," said Jan van Gerich, chief analyst at Nordea.
"The big picture remains that central banks are worried about being behind the curve and need to catch up."
The currency jumped almost 1.8% against the euro to 1.0198. It was headed for the biggest daily rise since January 2015 when the SNB unhooked the franc from its euro peg, sending the currency soaring.
Against the dollar, the franc rose 1.4%.
On bond markets, yields on 10-year Swiss bonds rose 18 basis points at 1.51% while two-year borrowing costs were up more than 22 bps.
Swiss stocks plunged after the decision was announced, losing almost 3% and underperforming the pan-European STOXX index which fell 2%.
A Swiss equity trader said franc strength was adding to pressure on stocks in the exporter-heavy bourse, which is now close to confirming a bear market.
Shares in Switzerland's big banks Credit Suisse and UBS fell 3.3% and 4.8% respectively.
Switzerland and Japan had been the only two major developed world central banks yet to raise interest rates in a tightening cycle that started last year. Many central banks are raising rates in 50 bps instalments.
But Swiss rate hike expectations were fanned by recent data showing inflation at a nearly 14-year high. The European Central Bank also signalled it will kick off rate hikes in July.
Analysts at currency broker Monex said Swiss inflation was mostly coming through the trade channel while the SNB unofficially targets a stronger inflation-adjusted franc rate to reduce imported inflation.
"Widening monetary policy differentials threatens this objective, hence warranting an earlier than expected rate hike. Today's decision to surprise markets has had the desired effect for the SNB as the euro-franc dropped over 1.5%," Monex wrote.
SNB Governor Thomas Jordan flagged more rate hikes ahead, noting the franc was not as highly valued as it used to be.
Traders have taken that as a cue to price even more aggressive tightening -- money markets are betting on a 100 bps move at the SNB's Sept. 22 meeting.