NEW YORK, (Reuters) - The US dollar rose on Friday, posting its best weekly gain in two months against the euro, after a government report showed job losses in December were slightly lower than expected.

Traders have sold the dollar since a private sector jobs report on Wednesday indicated further weakness in US labour markets.

Many of those bearish dollar bets were rapidly reversed, triggering a dollar rally when the Labour Department reported losses of 524,000 jobs last month, slightly better than Wall Street estimates of 550,000 losses.

"December's non-farm payroll report was unequivocally awful, but considering that many investors actually expected even worse results, there was some sense of relief after the release," said Meny Grauman, an economist at CIBC World Markets in Toronto.

This "modest silver lining", he added, temporarily managed to push the dollar higher.

The Japanese yen surged as well, with traders selling risky bets in stocks, commodities and higher-yielding currencies funded by the Japanese unit's low rates.

While the non-farm payrolls report was better than expected, it still painted a grim picture for the world's largest economy and added to worries about a deepening recession worldwide.

In late afternoon trading, the euro fell as low as $1.3416. It was last at $1.3431 , down 2.1 percent on the day. The single currency has fallen more than three percent on the week versus the dollar, the largest weekly loss since the last week of October.

The ICE Futures' dollar index , a gauge of the greenback's value versus six major currencies, rose 1.3 percent to 82.652. The dollar rose two percent versus the Swiss franc to 1.1147 .

Against the yen, the dollar dropped 0.8 percent to 90.36 . Yen strength has pushed the euro down almost three percent, to 121.37 .

Despite the dollar's rebound, analysts said there was plenty in the jobs report that bodes ill for the US economy and its currency.

"No matter how you look at it, those are dismal numbers. The payrolls headline was a tad better than the consensus forecast but we had a considerable jump in the unemployment rate," said Matt Esteve, a foreign exchange trader at Tempus Consulting in Washington, DC.

The 7.2 percent unemployment rate was the highest in nearly 16 years and the upward revisions in November and October pushed total job losses in the last four months to 1.9 million.

Total job losses for 2008 were 2.6 million, the largest decline in 63 years.

"The US is in recession and in previous recessions, job cuts have lasted for at least 15 months," said Kathy Lien, director of currency research at GFT Forex in New York.

She noted the US economy has seen 12 consecutive months of job losses, which suggests that non-farm payrolls will not turn positive until the second half of the year.

Data earlier showed showed a bigger-than-expected drop in French industrial output, adding to the argument that the euro-zone economy is further deteriorating, which kept selling pressure on the euro. .

The euro ultimately received little support from an unexpected rise in euro-zone retail sales as the outlook for consumer demand remains weak amid plunging business morale and growing unemployment. .

Adding to the pressure was news S&P cut Ireland's ratings outlook to negative from stable and placed Greece's sovereign rating on negative watch.

That should increase the pressure on the European Central Bank to boost the pace of its rate cuts, analysts said.