Right now, combat is still fun but becomes trivial once you reach level 3-5.
What is the tiping point ? Why does it become so easy suddenly ? Maybe that would hint to some changes .
My tipping point was finding a decent weapon. Bfore = fights frustratingly hards. After = fights frustratingly easy.
For me it's much more about skill diversity and thus variety of possibilities. Shitty weapon makes combat more tedious, but not really harder.
However, once you get a hold of "combos" like teleportation/blitzbolt/oil/flare and you also have an archer, for instance, you can easily stun ennemies, keep them at range when they're finally closing in, etc. and damage them from afar, while the poor undead swordsmen and zombies don't have that kind of arsenal to oppose you.
Granted, the amount of possibilities you get as a player in combat is also what makes the game's fights unique and so enjoyable, thus I don't think you want to limit the player more there. I'd say that's where resides the difficulty on making this game's combat both challenging and interesting in the long run.
I guess the people who had the hardest time with combat at this point were those who hesitated to diversify and built characters focused around one archetype, like they're used to in "classful" games, mmos and the like.
To be fair, some of the higher levels encounters might be more challenging if you don't have the right tools, but by level 6, your party should be able to tackle any kind of opponent, be it fire elemental, pirate ghosts and whatever its particular immunities etc. will be. I'm still confident they have much more in their pockets for the final release, though. (Those environmental effects seem nasty, I think starting in the next area after Cyseal "weatherman" is going to become a must have.)
As for the level of the citizens, and guards especially, in the city, I'd agree that it's maybe a little too low... but I also agree with LordCrash here : why would you absolutely want to kill everybody, and why is it a problem if it's easy to do so ?
Also, making really overpowered guards could be a problem for those few starting encounters near the gates where it's easy to draw the city watch in to help...
