Domestic job growth accelerated in May and the unemployment rate dropped to an 18-year low of 3.8 percent, pointing to rapidly tightening labor market conditions. The US Labor Department's report also showed solid wage gains, making a rate hike in June near-certain, and increasing expectations of a fourth hike this year.
Bets by traders in short-term interest-rate futures showed confidence in hikes in June and September, and see about a 36 percent chance of a rate hike in December, up from about 32 percent before the report. The Fed has raised rates once this year so far, in March.
Against a basket of six currencies, the dollar rose half a percent to a session high of 94.45. The move, however, was relatively muted compared to the blockbuster jobs numbers.
That's because "the market was fairly pricing the Fed's path coming into the number, which was a shift from the beginning of the week where the market took out some of the rate hikes," said Charles Tomes, senior investment analysts at Manulife Asset Management.
Political turmoil in Italy earlier this week drove the dollar index to a 6-1/2 month high, but expectations of a fourth rate hike in 2018 decreased over fears of a euro zone crisis.
The euro edged higher on Friday and looked set to break a six-week losing streak, supported by a drop in Italian bond yields after a revived coalition deal between two anti-establishment parties pulled the country back from snap elections.
With receding worries that political turmoil in Italy would roil markets, investors have - after strong inflation data this week - shifted their focus back to predicting when the European Central Bank will raise interest rates.
Annual inflation in the 19 countries sharing the euro rose to 1.9 percent in May from 1.2 percent in April, well above expectations for a 1.6 percent increase.
"After the roller-coaster ride in the euro this week, markets are back to focusing on fundamentals and the inflation data will give food for thought to those who are betting on a sustained euro decline," said Marc Ostwald, global strategist at ADM Investor Services International based in London.
On Friday, the single currency edged 0.2 percent higher to a session high of $1.1717. On a weekly basis, it is set to climb 0.5 percent, breaking six-week losing streak.