Switzerland's central bank stepped in to stop investors driving up the franc on Tuesday, sending the euro up nearly 9 percent and stifling a tentative European stock recovery from sharp losses a day earlier.

Core German debt yields, however, stayed near historic lows, well below 2 percent, signaling a frenzied search for safety was continue.

European banking stocks, battered by fears of exposure to both euro zone peripheral debt and a U.S. lawsuit over mortgage-backed securities, added to Monday's losses.

The Swiss National Bank whipped up the markets, saying it was setting a minimum exchange rate target of 1.20 francs to the euro that it will enforce by buying foreign currency in unlimited quantities.

The franc has soared against the euro and the dollar in recent months as investors have bought the currency as a safe place for their money given the U.S. and euro zone debt crises.

This has threatened the Swiss economy, the bank said.

Soon after the announcement, the euro was trading at just above the 1.20 Swiss franc target after earlier being at around 1.10 francs.

The euro also rose against the dollar and was trading at $1.4173

One will think twice about speculating against this target because the SNB is with its back against the wall, said Alessandro Bee, economist at Bank Sarasin.

The Swiss move, however, undermined what had been a tentative European stock rally.

STOCK LOSSES

World stocks as measured by MSCI were up 0.2 percent, mainly held back by a catch-up fall of 2.2 percent on Japan's Nikkei.

The pan-European FTSEurofirst 300 was up a quarter of a percent, while the banking sector remained under stress, falling 0.1 percent.

European stocks fell more than 4 percent on Monday on renewed worries about the euro zone's ability to solve its debt problems.

These persistent euro zone worries are back in play once again amidst signs that austerity measures may be faltering, whilst last Friday's disappointing (U.S.) non-farm payrolls (data) continue to leave the markets with something of a hangover, said Cameron Peacock, analyst at IG Markets.

At a banking conference in Frankfurt, the chief executives of both Societe Generale and Commerzbank said bank earnings would be less in the future, partly as a result of the euro zone crisis.

There is a direct link between state balance sheets and bank balance sheets, Commerzbank's Martin Blessing said, adding that about 50 percent of sovereign bonds are held by local banks in most countries.

Market reaction to the euro zone crisis is being exaggerated by global concern about the state of the U.S. economy, which is in danger of slipping back into recession.

Europe's own economy is also weak.

Japanese, Chinese and South Korean financial regulators discussed the global threats in a conference call.

We are already at stall speed in the U.S. and Europe, which means we are now more likely than not to see a recession, said Tharman Shanmugaratnam, Singapore's finance minister.

(Additional reporting by Atul Prakash, Jonathan Gould and Edward Taylor)

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