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The question of how bank shares will respond to the new tax on deposits will be a key factor for the ASX 200 index today.  

Even though details of the tax are now known, it may be some time before markets get a firm handle on the extent of its impact on bank profits. This will depend on their ability to change their funding mix to avoid the tax on the one hand and to pass the cost on to customers on the other.

The big 4 banks’ ability to pass the cost of tax on to customers may, at least at the margin, be constrained by competition from smaller banks in the retail market and offshore competitors in the institutional market.

 There is now a tax related competitive advantage for smaller banks.  This suggests that the shares of Bendigo and Adelaide Bank which were caught up in yesterday’s selling of bank stocks may recover today.

While it may take some time to assess the impact of the new tax on bank profits it’s likely to be seen as a negative for valuations. There’s a clear risk to bank profits. This funding disadvantage may also crimp bank’s future growth and lending capacity by increasing the marginal cost of funds and limiting their appetite for higher cost funding.

Outside the banks overall market response to the budget is likely to be mildly positive with infrastructure stocks in particular, likely to benefit from future increases in government spending

The Aussie Dollar has suffered at the hands of yesterday’ s weak retail sales data combined with a stronger US Dollar overnight. While the March quarter weakness in retail sales is likely to have been partly attributable to weather, any improvement this quarter will be coming from a low base and will be one factor keeping the RBA firmly on hold with interest rates.