* Franc breaches 1.20 level for first time
* SNB vows to keep defending level
* First big test of SNB resolve
ZURICH, April 5 (Reuters) - Investors tested the Swiss central bank's resolve to defend its currency policy on Thursday by driving the franc's value above a cap that has held since September and that is intended to protect the economy.
Foreign exchange traders said the central bank bought euros as the Swiss franc closed in on and then broke through the 1.20 per euro limit.
"We won't accept any exchange rate below 1.20. We are committed to buying foreign exchange in unlimited quantities to defend this level," a spokesman for the SNB said.
The euro zone's sovereign debt crisis has sent investors scurrying for safety in the franc. A new wave of fears this week over the ability of Spain, the euro bloc's fourth largest economy, to manage its public and private sector debt burden has weakened the euro against most major currencies.
Fears that a surging franc could hurt Swiss exporters and the nation's tourism industry, tipping the economy into recession, drove the SNB to cap the currency on Sept. 6. It has vowed unlimited interventions if needed.
On Thursday, the franc surged to a 7-month peak of 1.1990 per euro on EBS trading platform. It was last at 1.2018 francs per euro at 1102 GMT, 0.2 percent weaker on the day.
The SNB declined to confirm or deny whether they had been buying euros.
"Certainly, the sharp bounce and the fact that stops (stop-loss trading) did not trigger a sustained lunge lower in euro-Swiss would be consistent with suggestions that the SNB was in the market," said Daragh Maher, currency strategist at HSBC.
"The central bank was also quick to reassert its earlier statements that it would intervene in an unlimited way to defend their FX strategy," Maher said.
Some traders said it was euro weakness, rather than franc strength, which prompted the cap's breach.
"Effectively the euro is weak against everything today, including versus the franc. The market is not at all liquid ahead of the Easter holidays," said Giuseppe Manieri, who manages 900 million francs at fund manager Premium Currency Advisers.
"The move was seen as primarily stop-loss driven, with the market gapping lower after bids at 1.2030 got filled. We estimate 1-2 billion euros was sold at 1.20," Citi foreign exchange analyst James Thornhill said.
Traders had been reluctant to test the SNB's credibility after getting burned just after it introduced the cap, which knocked some 8 percent off the franc's value in one hit.
Prior to that, SNB intervention to rein in the currency had been less successful. The central bank ran up huge losses in 2010 trying to keep a lid on the franc, prompting calls for then chairman Philipp Hildebrand to step down.
The SNB has been using foreign exchange swaps and other measures to boost liquidity in the money market to weaken the franc. Data released on Thursday showed the SNB's foreign currency reserves rose in March to 237.5 billion Swiss francs.
Recent data shows the cap is helping to stabilise the economy, even though the currency remains some 30 percent stronger than it was before the crisis, prompting calls for more central bank action.
Swissquote analyst Peter Rosenstreich says data on Thursday showing a greater-than-expected rise in inflation had eased pressure on the SNB to do more to weaken the currency, prompting traders to test the limit.
"We think that the uptick in inflation today might have been the catalyst" for the attack on the cap, Rosenstreich said, predicting the central bank will actively defend the cap.
"Given their past statements on "unlimited funds" and credibility issues, we suspect that the days of just verbal intervention are over."