UPDATE 2-New UK government gives itelf five percent pay cut

* New govt awards itself a 5 percent pay cut

* Britain has first coalition government for decades

* Must tackle record deficit; markets positive so far

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By Keith Weir

LONDON, May 13 (Reuters) - Britain's new coalition government cut its own pay by five percent on Thursday in a sign of the tough medicine the country faces to bring down a record budget deficit.

The centre-right Conservatives and smaller centrist Liberal Democrats agreed on Tuesday on what critics call an unstable partnership of expedience after an inconclusive election.

Reducing Britain's record budget deficit of over 11 percent of national output will be the first test of the relationship.

Ministers met around the cabinet table for the first time on Thursday and promptly awarded themselves a pay cut.

Prime Minister David Cameron will see his annual salary cut to 142,500 pounds ($210,500) from 150,000, while senior ministers will be paid just under 135,000 pounds -- a very healthy salary in Britain.

Ministers' pay will be frozen for the five-year lifetime of the parliament in measures expected to save a total of three million pounds -- a drop in the ocean when weighed against a deficit forecast to reach 163 billion pounds this year. Markets are looking for signs the Conservative-led coalition will act quickly to reduce the deficit by trimming public spending, initially by 6 billion pounds this financial year.

"We are all very aware of the seriousness of the situation and frankly if we don't have a credible programme to reduce the deficit...then we won't have the confidence of the markets and the confidence of the country," Culture Secretary Jeremy Hunt told reporters after the hour-long meeting.

The Conservative manifesto contained a pledge to freeze pay for public sector workers next year, excluding the one million lowest paid.

SALES TAX RISES?

The government has promised an emergency budget within 50 days. Cameron said on Wednesday the government had the worst economic inheritance of modern times in Britain.

Economists quoted by British media said they also expected a rise in the VAT sales tax from the current 17.5 percent.

The head of British supermarket group J Sainsbury (SBRY.L) said on Thursday that consumer spending would remain subdued and the focus should be on spending cuts rather than raising taxes to clean up finances.

"If the government does decide to increase VAT, they should give us good notice and they should be firm on the fact that that is going to stick for a very long time," King told BBC radio. "We don't want to see VAT swinging around in an uncertain and unpredictable way. It's very costly and complex for retailers to change VAT."

Other legislation expected on the agenda soon is a plan for a banking levy, a commission to investigate separating retail and investment banking and plans to give the Bank of England more clout as a financial watchdog.

The atmospherics of the new partnership between Conservative leader Cameron and his deputy Liberal Democrat leader Nick Clegg dominated newspapers, with most focusing on their new friendship after weeks of sniping at each other on the campaign trail.

Commentators warned of trouble ahead given the two parties' traditional ideological differences and Britain's lack of experience with coalition rule. The new parliament includes a large number of new members with little Westminster experience.

However, markets have so far reacted positively to the commitment to make an early start on spending cuts. Turmoil in the eurozone has also given British assets greater appeal.

Legislation will be introduced to give parliaments five-year fixed terms, but the lower house could still be dissolved if 55 percent or more of lawmakers vote in favour.

The coalition government ends 13 years of Labour party rule under Tony Blair and then Gordon Brown. (Additional reporting by Mohammed Abbas; Editing by Mark Heinrich)