The franc, which has surged by about 20 percent as investors seek refuge from the eurozone crisis, dropped nearly 10.0 percent after the central bank issued this and other signals that it would fight the inflow of funds.
The bank said that it stood ready with more measures to ring fence the franc.
"With immediate effect, (the SNB) will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20," the Swiss central bank said in a statement.
"The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development," it said.
But analysts warned that this line in the market would be hard to defend.
Switzerland is not a member of the European Union and so is not a member of the eurozone, but its economy is heavily dependent on exports notably to the eurozone, and the rise of the franc is hitting industry and tourism hard.
The franc dropped sharply, rallied narrowly and settled within small margins of the new exchange rate, around 8.5 percent lower than at the beginning of the day.
The stock market surged by 5.20 percent at first, then showed a gain of 4.5 percent to 5,373.93 points.
Switzerland, with a sound balance sheet and a growing economy, has proved to be an attractive option for those fleeing economic turmoil abroad.
With investors keen to hold francs, the currency has risen significantly. In early August it was up about 20 percent against the euro -- briefly flirting with parity -- and 25 percent against the dollar compared to 2009, to the detriment of local exporters.
To discourage investment in the franc, the SNB cut its base lending rates to almost zero in August and increased liquidity three times, but with apparently little impact.
One typical tool for a central bank in such circumstances is to go on cutting rates. But now the central bank had few options other than to peg the currency, said Picte bank analyst Bernard Lambert.
"The franc was rising quite quickly the last few days because of what was going on in Europe," he told AFP. "If (the SNB) had not done anything, the movement would continue.
Lambert explained that the peg would require the Swiss National Bank to buy large amounts of euros to stabilise the franc, but this would be successful only if investors believed that the central bank was determined.
"If the move is credible, you do not have to buy euros," Bernard Lambert, an analyst at Pictet told AFP.
"But if the crisis continues, the SNB will have to spend billions," he said.
An analyst at bank Julius Baer told AFP the SNB would have to spend an estimated maximum of 80-100 billion francs (€66.5 to 83.1 billion) per day to implement its new policy.
"In a week (that is) more than the Swiss GDP," he said.
That view was shared by investment bank Goldman Sachs which said that the policy would be credible only "as long as the authorities are prepared to accept the liquidity implications of this potentially very large intervention."
This was a reference to the fact that to buy euros, the central bank will have to put other means of exchange into the market from reserves, and also Swiss francs into the Swiss money supply.
But Natixis bank said that economic developments abroad would determine the success of the policy.
"Keeping in mind the experience of last year, a target of 1.20 in the current environment of debt crises in the US and the eurozone will be hard to defend," it said.
None of the analysts however seemed particularly concerned about inflationary risks, with Goldman Sachs saying it was "remote".
Some analysts were also sceptical about the effect on the Swiss economy.
"The SNB's decision to apply a floor of 1.20 per euro to the Swiss franc is a bold move, but that level is still relatively high, implying that the economy will suffer nonetheless," an analyst at Capital Economics said.
There is still "substantial overvaluation" even at the new exchange rate, Goldman Sachs concurred.
The SNB added however it had "the utmost determination and is prepared to buy foreign currency in unlimited quantities," saying that the peg value was "still high" but that further measures could be taken if deflationary risks persisted.