* Claimant count rise smallest since May 08
* Smallest quarterly rise in ILO jobless level since July 08
* Jobless still seen hitting 3 million in 2010
(Updates with reaction, details)
By Matt Falloon and Fiona Shaikh
LONDON, Oct 14 (Reuters) - The number of Britons claiming jobless benefit rose by its smallest amount in almost 1-1/2 years in September, according to official data, in a sign the worst of the job-shedding due to the recession may be over.
But lay-offs are likely to last throughout 2010, which could prove awkward for Prime Minister Gordon Brown, who must fight an election by next summer, and for any new administration which may have to cut public sector jobs to shore up state finances.
The Office for National Statistics said claimant count unemployment rose by 20,800 last month, below forecasts for a 25,000 gain and the smallest rise since May 2008. That took the rate to a 12-year high of 5.0 percent from August's 4.9 percent.
The number of people without jobs on the internationally comparable ILO measure rose by 88,000 to 2.469 million in the three months to August, leaving the jobless rate at 7.9 percent, below forecasts for a reading of 8.0 percent.
The pound rose about half a cent against the dollar as the figures suggested that while unemployment is still rising in Britain, the rate of increase is easing -- a sign that the labour market may not be as hard-hit as some had feared.
"It does suggest that the pace of deterioration in the jobs market is easing quite sharply which is encouraging for the outlook for a sustainable recovery," said Philip Shaw, chief economist at Investec.
The ONS said the increases in the ILO unemployment level and rate were the smallest since May-July 2008, although the 7.9 percent rate equals the figure for May-July 2009 which was the highest since Sept-Nov 1996.
While Wednesday's figures add to the raft of recent encouraging news on the economy, there is still a great deal of uncertainty about the strength of any recovery and analysts said policymakers were unlikely to want to start unwinding their stimulus measures for some time yet.
Indeed, with the government under pressure to cut spending to bolster the public finances, job losses in the public sector -- which employs a fifth of Britain's workforce -- could still drive unemployment above 3 million next year.
"Before long, the labour market will face an additional squeeze from the looming fiscal consolidation," said Vicky Redwood, economist at Capital Economics.
"We think the fiscal squeeze could require around three quarters of a million job losses in the public sector.
LONG WAY TO GO
Even though the economy is showing signs of emerging from recession, it is likely to be quite some time before demand is strong enough for firms to start creating jobs again.
The ONS said the number of job vacancies in the economy fell to 422,000 in September, the lowest since records began in 2001.
Britain's economy has shrunk by around 5.5 percent over the last year, and analysts reckon unemployment will not start falling until growth returns to its long-run trend rate of 2.5 percent -- not expected until at least 2011.
Still, companies have not been shedding jobs as fast as has been the case in past recessions, probably due to the increased flexibility of the labour market.
Across Europe, there has been evidence that workers have accepted pay freezes, shorter working hours and other changes to their conditions to protect their jobs.
In Germany, for example, a government subsidy scheme, known as "Kurzarbeit", that encourages companies to reduce the hours of their workers instead of firing them, has prevented mass lay-offs during the deepest part of a sharp industrial downturn.
In Britain, many companies have opted to cap wages rather than cut jobs, with a survey by the Engineering Employers' Federation showing that 4 out of 5 manufacturers froze pay in the three months to October -- a survey high.
This trend also came through in Wednesday's official data, which showed that annual average earnings growth including bonuses eased to 1.6 percent in the three months to August from 2.2 percent in the three months to July.
Excluding bonuses, annual average earnings growth fell to 1.9 percent on the year in the three-month period -- the lowest since records began in 2001. (Reporting by Matt Falloon and Fiona Shaikh; Editing by Stephen Nisbet)