* Q1 adjusted jobless rate 7.3 pct, highest since Q1 '06
* Number of employed falls for first time since 1995
* Jobless giving up search for work in poor southern regions
By Gavin Jones
ROME, June 19 (Reuters) - Italy's jobless rate rose in the first quarter to its highest level for three years and employment fell for the first time since 1995 as the recession continued to take a heavy toll on the labour market.
The seasonally-adjusted unemployment rate increased to 7.3 percent from 7.0 percent in the previous three months, matching expectations and reaching its highest level since the first quarter of 2006, but analysts said the worst was still to come.
"The fall in employment will accelerate in coming months, we expect to see the jobless rate above 9 percent by the end of this year and to continue to rise in 2010," said Luigi Speranza of BNP Paribas.
Employers' association Confindustria estimated on Thursday that at least one million jobs would be lost in the two years ending in the first quarter of 2010.
On an unadjusted basis, unemployment jumped to 7.9 percent in the first quarter from 7.1 percent a year earlier, the data from national statistics bureau ISTAT showed on Friday.
"The economic crisis is having an evident impact on the labour market," ISTAT said.
The euro zone's third largest economy contracted by 2.6 percent between January and March, the fourth consecutive quarterly drop in gross domestic product and the steepest fall for at least 30 years.
The Organisation for Economic Cooperation and Development (OECD) forecast on Wednesday a 5.3 percent contraction in Italian GDP this year after a 1.0 percent GDP drop in 2008. It forecast unemployment would reach around 10 percent in 2010.
The number of Italians in work fell by 426,000 in the first quarter from a year earlier, ISTAT said, partly offset by a rise of 222,000 in employment among immigrants doing largely unskilled jobs.
Employment was down 0.9 percent year-on-year and down 0.3 percent from the previous quarter.
NO SAFETY NET
At the same time, growing numbers of large- and medium-sized firms are temporarily sending workers home on reduced pay using the "cassa integrazione" fund paid for jointly by employers and the government.
The number of workers at home but still officially employed under this scheme leapt four-fold in the first quarter 245,000 from 61,000 a year earlier, ISTAT said.
Temporary workers and employees in small firms have no such safety net and are considered the most vulnerable to the economic recession.
An ISTAT spokeswoman underlined a sharp 2.5 percent annual fall in employment among people under the age of 35, those hardest hit by the companies failing to renew fixed-term contracts.
She also pointed to a continuing increase in the inactivity rate in the poor southern regions of the country where increasing numbers of jobless people, especially women, have given up looking for work altogether.
Italy's jobless rate has been on a gradually-rising trend since touching a low of 6.1 percent in the second quarter of 2007.
Analysts say Italy's real challenge lies in raising its employment rate -- which remains well below the euro zone average, particularly among women -- and increasing its activity rate, or the sum of people working or looking for work.
The employment rate dropped sharply in the first quarter to 57.4 percent from 58.3 percent a year earlier. (Editing by Toby Chopra)