Audio problem: On the way back to the house, in the back of the horse cart, Babe and Fly are talking to each other. They never open their mouths while they're talking.
Audio problem: There are a few points throughout the film when the animals talk, but their mouths don't move.
Answer: Rex means that they are both part of the sheepdog family, not that they are closely related. He thinks that when Fly told Babe about sheep-herding, she disgraced her whole species.