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The Otago Regional Council said results from the weekly samples taken at the lagoon showed high levels of potentially toxic cyanobacteria (blue-green algae).
Cyanobacteria can produce toxins which may cause serious illness in people and animals.
Council lakes scientist Hugo Borges said potentially toxic algae occurred naturally and blooms were more common during summer, when low rainfall, warm temperatures, the right level of nutrients, and more sunlight created an environment where it could thrive.
It was not possible to predict how long the algae would take to recede.
"The most important thing is to keep out of the water until the warning is removed," he said.
The regional council has installed warning signs at the entrance to the upper lagoon and at the creek that enters Tomahawk Beach as a precaution in the event the wind sweeps the algae down.
All warning signs would remain in place until monitoring showed the algal bloom had reduced and weekly samples were consistently below levels posing any threat to health.