In a landmark ruling, the supreme court judges voted unanimously to restore Chaudhry, and 10-3 to quash charges of misconduct that Musharraf had sent to a separate judicial tribunal.
The surprise verdict, on an appeal from Chaudhry, was widely hailed as a democratic breakthrough in a country dominated by the military for most of its 60-year history.
Many had expected the court to reinstate him while letting the tribunal's investigation continue.
It also triggered fresh calls for Musharraf, who seized power in a 1999 military coup, to step down.
Cheers from lawyers, reverberated through courtroom on Friday, after Khalil-ur-Rehman Ramday, the presiding judge, announced that the judge's suspension was "illegal" and set aside the charges against him.
The lawyers had led mass protests against Musharraf since he suspended Chaudhry on March 9.
No 'political motive'
Chaudhry, who was expected to return to his supreme court office on Monday, has not commented on the ruling, which was accepted by Musharraf.
In Washington, Tom Casey, state department deputy spokesman, said the reinstatement "respects the rule of law" and praised the fact the court was "capable of making independent decisions."
Musharraf suspended Chaudhry for allegedly pulling rank to secure a police job for his son and enjoying unwarranted privileges such as the use of government aircraft.
The government insists the case had no political motive.
However, critics suspected Musharraf of plotting to remove an independent-minded judge to forestall legal challenges to his plan to ask politicians for another five-year term.