* Dollar falls 0.9 pct vs Swiss franc after government move
* Euro helped by short squeeze, German and French surveys
* Canadian dollar falls to new 4-1/2-year low, Aussie slumps
By Laurence Fletcher
LONDON, Jan 23 (Reuters) - The Swiss franc rose sharply against the U.S. dollar on Thursday after the Swiss government raised the level of capital that banks must hold against their mortgage books, tightening monetary conditions.
The euro also rose against the dollar after surveys of French and German business activity came in above expectations.
Comments from the Bank of Canada, which said currency depreciation should help exports, knocked the Canadian dollar to a 4-1/2-year low, however, while the Australian dollar tumbled back towards a 3-1/2-year low after a eaker-than expected survey of Chinese manufacturers.
The U.S. dollar was 0.9 percent weaker at 0.9031 francs and the euro was 0.3 percent lower at 1.2314 francs after the Swiss government's move, which coincided with this week's World Economic Forum in Davos.
The Swiss government cited "a considerable risk for the stable development of the economy" driven by strong growth in mortgage loans and residential property prices.
"This clearly shows the SNB (Swiss National Bank) is on a path where it can get more restrictive," said Ulrich Leuchtmann, head of currency research at Commerzbank in Frankfurt.
"It limits the upside potential for euro-Swiss franc," he added. "I don't think they'll abandon the 1.20 (per euro cap on the franc's value) but there will be enough speculation in the market about how long it can continue."
Others, such as Stephen Gallo, FX strategist at BMO Capital Markets, said the move could take away the need for a rate rise.
Gallo pointed to speculation that banks would need to sell foreign assets to meet the new requirements, thus lifting the franc. But he also said that the move was "ultimately negative for the Swiss economy" and negative for the franc medium-term.
The euro jumped 0.6 percent against the dollar to $1.3629, helped by a squeeze on traders betting against the single currency and data showing Germany's private sector grew at its fastest pace in more than 2-1/2 years in January. French business activity also shrank less than forecast.
"Those (investors) who had euro shorts for not a long time took the opportunity of momentum fading out to scale out of their positions," said Commerzbank's Leuchtmann.
On Thursday Greg Jensen, co-CEO of hedge fund firm Bridgewater Associates, said Bridgewater was short the euro.
"Europe is the one area of the world that needs significant easing," he told Reuters Insider.
The loonie, as the Canadian dollar is known, fell as low as C$1.1174 per U.S. dollar, its lowest level since July 2009, with volumes well above average levels over the past month. That brings its decline against the greenback this year to 5 percent.
The Bank of Canada said in its Monetary Policy Report that a strong currency is still hampering the country's exports.
Although the central bank stopped short of saying its next move is likely to be a rate cut, it also said it had become more concerned about weak inflation.
"It seems as though Governor Stephen Poloz may revert back to the BOC's easing cycle as the persistent slack in the real economy continues to drag on price growth," said David Song, analyst at DailyFX.
Although the Aussie appeared to have found good support below 88 U.S. cents after surprisingly robust inflation at home on Wednesday, it tumbled 0.9 percent to $0.8769 on Thursday , near a 3-1/2-year low of $0.8756 hit on Monday.
That came after the flash reading of the Markit/HSBC Purchasing Managers' Index (PMI) for China fell to 49.6 in January from December's final reading of 50.5.
One trader played down the importance of the survey, however, saying the fall offered a buying opportunity back up to $0.88.
The falls will be welcome for hedge funds, who are betting that both the Australian and Canadian dollars will weaken against a strengthening U.S. dollar as the Federal Reserve scales back its bond-buying.