In a shift from the Reserve Bank of Australia's long-standing tightening bias, Governor Philip Lowe said rates could move in either direction, depending on the strength of the labor market and inflation.
"The Aussie is definitely where the action is today," Minh Trang, senior currency trader at Silicon Valley Bank in Santa Clara, California.
"The language was a bit more dovish than expected," he said.
The policy shift caught some investors off-guard as the previous day the Reserve Bank of Australia had steered clear of an easing signal when holding its official cash rate at a record low 1.50 percent.
The Aussie was 1.66 percent lower at $0.711, on pace for its worst one-day decline in a year.
The sharp selloff also weighed on the New Zealand dollar and the Canadian dollar with both these currencies logging declines against their U.S. counterpart.
Lowe's speech highlighted a difficult balancing act facing policymakers as they try to manage market expectations and ease pressure on growth.
Both the U.S. Federal Reserve and the European Central Bank have signaled a cautious monetary outlook in recent days with the Fed's pause proving a relatively bigger surprise for markets.
"A year and a half ago a lot of the chatter was about central bank tightening," said Trang. "That narrative has changed to, not so much easy monetary policy, but certainly not as tight, in terms of where interest rates lie."
More broadly, the dollar index, which tracks the greenback versus the euro, yen, British pound and three other currencies, was up 0.32 percent at 96.38.
U.S. President Donald Trump's State of the Union speech on Tuesday held little in the way of surprises for currency traders.
Traders were focused on the near-term outlook for monetary policy as well as any sign of progress in trade negotiations between Washington to Beijing as a March 2 deadline for an increase in U.S. tariffs on Chinese goods nears.
U.S. Treasury Secretary Steven Mnuchin said on Wednesday that he and other U.S. officials will travel to Beijing next week for trade talks.
Sterling steadied on Wednesday but held near a two-week low as investors mulled a report that UK cabinet ministers are discussing plans to delay Brexit by eight weeks.