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Four-time world champions Italy dominated the entire game in Palermo but a sniping low shot from Aleksandar Trajkovski found the in the 92nd-minute to secure an unlikely 1-0 victory.
It was pure heartbreak for the Italians, who had 32 shots on goal in the match but could not find the back of the net.
"It is a huge disappointment," Italy midfielder Jorginho said.
"It hurts, it hurts so much.
"We have always created and dominated matches but we have not been able to finish teams off. It is not to blame anyone in particular but it is the reality.
"I don't know why we haven't been able to do this, I am also involved in this, and it hurts me to think about it."
The result sets up a massive opportunity for North Macedonia, who will look to play giant-killers once again as they take on Portugal on Wednesday (AEDT) for a place at the finals in Qatar.
The Portuguese booked their ticket through to the next round with a 3-1 win against Turkey.
Turkey had a chance to level the score at 2-2 when they were awarded a penalty with only six minutes left on the clock.
However, Burak Yilmaz spurned the chance when he missed the spot-kick before Matheus Nunes secured the win for Portugal with a goal at the other end moments later.
Gareth Bale scored a brace in a 2-1 victory over Austria to keep Wales' dream alive of playing at their first World Cup in 64 years.
Bale curled a free-kick into the top right corner in the 25th minute in Cardiff and smashed the second into the same place with a diagonal drive six minutes after the restart.
Bayern Munich midfielder Marcel Sabitzer pulled one back with a shot deflected by Ben Davis over the diving goalkeeper Wayne Hennessey a few minutes later but Wales hung on.
They will play for a spot in Qatar in June, with their opponents either Scotland or Ukraine whose game was postponed after the Russian invasion.
Sweden beat the Czech Republic 1-0 in Friday's other game.
The teams needed extra time before Robin Quaison grabbed the winner in the 110th minute to set up a clash with Poland, who advanced by walkover after the suspension of their opponents Russia.
Meanwhile, the 2022 FIFA World Cup draw will take place on April 2 in Doha - which you can WATCH LIVE, FREE and in HD on SBS.
