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Australia dollar overvalued as rebalancing act takes time: RBA

Australia's economic rebalancing away from the mining boom is still in its early stages, a top central banker said on Thursday, while cautioning investors they were underestimating the risk of sharp fall in the local dollar.

The warning on the currency from Reserve Bank of Australia (RBA) Governor Glenn Stevens had the desired impact - knocking the local dollar down half a U.S. cent to $0.9380.

Investors also took Stevens's comments as reinforcing the outlook for rates staying at record lows, and perhaps even nudging open the door for another cut if needed.

Read MoreAustralia central bank keeps rates steady, as expected

"The Governor has delivered his clearest statement yet that super-low interest rates are likely to be part of the economic landscape over the medium term," said Savanth Sebastian, an economist at CommSec.

Markets now put the chance of a cut in the 2.5 percent cash rate by year end at around 50-50, a shift that was encouraged by a disappointing reading on retail sales.

The Australian Bureau of Statistics reported sales fell 0.5 percent in May, the biggest drop in a year and confounding forecasts of a steady outcome.

Read MoreWhy Australia shares may be poised to rally

Speaking in Hobart, Stevens noted encouraging signs that low rates were working to support consumer demand, home building, employment and non-mining investment.

"But these signs remain early ones," said Stevens. "There is quite some way to go yet before the episode is completed."

The central bank has already gone almost 11 months without changing rates and continues to predict that the outlook is for more stability ahead.

David Wall Photo | Lonely Planet Images | Getty Images

Stevens emphasized that the bank had not given any thought to when it might raise rates and that while policy was very accommodative, it still had "ammunition" on rates given they were still well above zero.

Overvalued by any measure

One reason for the caution was the historically high level of the Australian dollar, which Stevens said was "overvalued" given falls in prices for the country's major commodity exports.

Read MoreAustralia economy grapples with new headwind

"We think that investors are underestimating the likelihood of a significant fall in the Australian dollar at some point," said Stevens, while also claiming that the bank was not actively trying to talk the currency lower.

The strong currency has been a thorn in the side of trade-exposed industries for months, forcing cost cutting and job shedding in some sectors.

On the brighter side, Stevens played down the impact of the Liberal-National government's unpopular May budget, arguing it was unlikely to have a material affect on the economy for the next year or so.

Read MoreAre the Australia dollar bears weakening?

Neither did he sound too concerned about the risk that a bubble had formed in the housing market. Mortgage growth had only been moderate so far and there was no evidence banks had loosened lending standards.

An ongoing increase in the supply of housing should help temper prices over time, he noted. Government data out Thursday showed approvals to build new homes surged 9.9 percent in May, the largest gain in eight months and above the most optimistic forecast.

"If the next couple of years saw an unremarkable performance on prices, and construction staying at the higher levels that will clearly be reached over the coming year, it would be an outcome that would contribute to a balanced growth path for the economy," said Stevens.

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