Some developments. Liberally flushed in-situ using WD40. Fiddled around with all the levers and buttons and it started working again. Here's the sequence:
1. Door will not latch - effectively its behaving as it would if you held the inside handle in the "open" position. Try to close it and it just bounces open.
2. Hold the inside handle in the "open" position and push the lock button down to the "lock" position.
3. Release the inside handle.
4. Lift the lock button up to the "unlock" position. The inside handle mechanism clicks and the door starts working again.
5. You can close the door as many times as you like and it will latch every time - provided you open it with the exterior button.
6. If you open it using the inside handle it may work once or twice but reverts to the "will not latch" fault state in step 1 above.
I am hoping someone has had one of these mechanisms apart and knows exactly what is going on and can suggest an easy fix. I can't buy one of these in Australia and even from the UK they all seem to be used. (Used may be OK - it sounds like no one on this forum has had any problems with this part.)
Meanwhile I am going to try lubing it some more.
EDIT. Just discovered that an alternative fix (eliminates steps 2, 3 and 4) is to slam the door a bit harder a few times. Something comes free and starts working again.