Preheat oven to 350 degrees F. In a medium bowl combine granulated sugar and flour. Stir in lemon peel, lemon juice, and melted butter. In a small bowl combine egg yolks and milk. Add to flour mixture; stir just until combined.
Beat egg whites until stiff peaks form (tips stand straight). Gently fold egg whites into lemon batter. Fold in cherries. Transfer batter to a 1-1/2- to 2-quart baking dish. Place the dish in a large pan on an oven rack. Pour hot water into the pan around the baking dish to a depth of 1 inch.
Bake for 40 to 45 minutes or until lightly browned and edges of cake spring back when lightly touched. Cool on a wire rack for 30 minutes. Serve warm sprinkled with powdered sugar or cover and chill for up to 24 hours.