UPDATE 1-Australia employment gains, but jobless at 29-mth high

(Adds market reaction, detail)

* Employment rises 14,500 in Sept, vs forecasts of +3,750

* Jobless rate 5.4 pct, against 5.3 pct expected

* Aussie dollar rises a third of a cent after data

* Market still flagging another rate cut by Christmas

SYDNEY, Oct 11 (Reuters) - Australian employment rose by more than expected in September but unemployment also jumped to the highest in over two years as more people looked for work, a mixed report that should not challenge market expectations for more cuts in interest rates.

The Australian dollar

rose a third of a cent after government data showed employment rose 14,500 in September, compared to forecasts for a slight rise of 3,750. Full-time jobs jumped by 32,100 in the month, while part-time employment fell by 17,700.

However, the jobless rate also surprised by increasing to 5.4 percent from 5.1 percent in August and above forecasts of 5.3 percent. That was the highest reading since April 2010.

Weakness in hiring was a major factor behind last week's decision by the Reserve Bank of Australia (RBA) to cut its cash rate by a quarter point to a three-year trough of 3.25 percent.

And it is one reason investors expect more easing to come. Interbank futures

imply rates at 3 percent by Christmas with a better than even chance of a cut next month, but expectations were scaled back somewhat after the data.

The jobless rate has been remarkably steady between 4.9 and 5.4 percent for over two years now, even though employment growth has been subdued.

However, that steady performance was partly due to an unusually large fall in the participation rate, which has dropped a full percentage point since late 2010 to a five-year low of 65.0 percent in August.

RBA policymakers suspect the fall in participation means the labour market is softer than implied by the jobless rate alone, allowing more scope for stimulus without the risk of igniting wages or inflation.

(Reporting by Wayne Cole; Editing by John Mair)

((Wayne.Cole@thomsonreuters.com)(612 9373 1813)(Reuters Messaging: wayne.cole.thomsonreuters.com@reuters.net))