* Gilts outperform Bunds on fiscal hopes, dovish BoE
* Sterling steady vs euro, dollar as investors await detail
* FTSE-100 lags Europe gains, concerns about spending cuts
By Fiona Shaikh and Neal Armstrong
LONDON, May 12 (Reuters) - Britain's financial markets had mixed fortunes on Wednesday as relief about Britain's new Conservative and Liberal Democrat coalition was tempered by concerns about the harsh austerity measures that lie ahead.
Surprisingly dovish quarterly growth and inflation forecasts from the Bank of England reinforced expectations the economy could be in for a rough ride while spending cuts and tax rises are implemented to deal with Britain's record budget deficit.
BoE Governor Mervyn King said the new government was right to start making cuts this year to convince markets of its determination to tackle Britain's record budget deficit, but warned of hard times ahead.
"It's not going to be easy. It's going to be a difficult few years as we face these adjustments," King told a news conference after the BoE published its Inflation Report.
The pound fell almost a cent against the dollar before steadying to around $1.4937 by 1203 GMT. The euro strengthened by half a cent against the pound to a session high of 85.12 pence after strong euro zone data, but subsided to 84.98 pence by midday GMT.
"The bottom line is that CPI will stay under the 2 percent inflation target ... interest rates won't rise as much as market expectations. Sterling sold off on this," said Adam Cole, global head of fx strategy at RBC.
Short sterling interest rate futures from March 2011 out were as much as 10 ticks up and analysts said contracts were now not pricing in rate hikes from the BoE until next year.
Conservative Party leader David Cameron, whose party won the most seats in last week's inconclusive election, took over as British prime minister late on Tuesday after the sudden resignation of Gordon Brown ended 13 years of Labour rule.
Cameron will lead Britain's first coalition government since 1945 with Lib Dem party leader Nick Clegg as his deputy and the Conservatives' George Osborne as finance minister.
Gilt futures outperformed their euro zone counterparts by almost half a point on expectations that the coalition would enact measures swiftly to shore up the public finances.
The new government is expected to implement Conservative plans to cut six billion pounds of spending this financial year, earlier than Labour or the Lib Dems had campaigned for.
And the gilt contract hit a session high of 117.36 -- up almost 80 ticks on the day -- after King said it would be wrong to rule out the central bank extending its quantitative easing scheme, but it was trading at 117.04 by 1214 GMT.
In the cash market, the spread between 10-year gilt and Bund yields -- a barometer of investor sentiment -- narrowed to 91 basis points from around 96 on Tuesday. It had tightened to just 85 basis points -- a six-week low after King's comments on QE.
The internationally focused FTSE 100 was up 0.4 percent, underperforming greater gains for the pan-European FTSEurofirst 300.
"There's relief a stable government is in place to lead the country, but it can't hide the fact there are huge economic issues for them to address, and that is what is dragging some stocks lower," said Jimmy Yates, head of equities at CMC Markets.
DEVIL IN THE DETAIL
Cameron's succession removed some of the uncertainty that drove sterling to a 13-month low against the dollar last week after an inconclusive election gave no party an absolute majority in parliament.
Analysts said investors were now waiting for more detail on the new administration's debt cutting plans.
The Conservatives had pledged in their election manifesto to hold an emergency budget within 50 days of entering office.
The dire state of the UK's public finances, with a budget deficit of over 11 percent of GDP, has been a cause of concern for ratings agencies, with investors sensitive to the potential for a downgrade of the UK's sovereign rating which would hamper efforts to pay off the deficit.
"If they manage to put through the austerity measures, you can presume the triple-A rating is pretty safe," said Charles Diebel, strategist at Nomura. "But that's a slow burn. It's cold hard facts we're waiting for now."
Ratings agency Fitch said the 5-year fixed term parliament agreed by the coalition should help maintain the government's focus on the medium-term fiscal outlook, although it was waiting for detail on the course of action it will take.
"While the coalition is uncharted territory, the agreement to a five-year term reduces the risk of a government of short duration which may have less incentive to focus on medium-term fiscal challenges," Fitch said in a statement. (Additional reporting by Simon Falush, editing by Stephen Nisbet)