What happens to the economy if we follow NSW and fail to eliminate the Delta variant of Covid-19?
Sydney-based research group Capital Economics has modelled an economic scenario for New Zealand based on the assumption that restrictions will now remain in place until near the end of this year.
But as grim as that prospect is, it does not mean economic collapse.
The most obvious shift in Capital Economics' forecasts is that they see the Reserve Bank delaying rate hikes until May in this scenario.
"The current outbreak is New Zealand's first encounter with the Delta variant, which across the world has proven to be much more difficult to control than previous variants, writes Australia & New Zealand economist Ben Udy, in his relatively pessimistic assessment.
"Admittedly, the lockdown is extremely strict as non-essential construction and manufacturing are banned and restaurants aren't even allowed to sell takeaway food," he says.
"But given the extensive spread of the virus before the lockdown, we suspect cases will continue to rise in the weeks ahead".
With New Zealand's policy to continue with its zero-Covid strategy even once most of the population is vaccinated, the failure of level 4 to completely eliminate Covid would mean that restrictions will have to remain in place for the foreseeable future, Udy says.
However he argues that the Government would likely abandon that strategy and adopt a similar plan as Australia, keeping restrictions in place until 70 per cent of the adult population is vaccinated - towards the end of the year at current rates.
The New Zealand economy has shown it has the strength and resilience to cope with this scenario, Udy says.
This scenario could see a 2.5 per cent decline in activity in the third quarter followed by a stagnation in the fourth quarter of the year, he forecasts.
"That's much smaller than the 9 per cent [q/q] decline in Q2 last year. But we suspect that consumption and investment will prove more resilient this time around as has been the case during repeated lockdowns elsewhere," he says.
Exports were unlikely to suffer as there was no universal tightening of restrictions overseas.
However, activity would clearly be much weaker than the RBNZ recently forecast, "especially in the very near term", he says.
On that basis Capital Economics now sees unemployment rising to 4.3 per cent.
Udy notes that the reintroduction of wage subsidies and the high level of job vacancies prior to the Delta outbreak will prevent a sharp deterioration.
On the assumption that the Reserve Bank won't be keen to hike while restrictions are in place, Capital Economics shifts its call for a first rate hike to May.
However, it then expects the tightening cycle to resume, forecasting five rate hikes until the OCR reaches 1.50 per cent by mid-2023.
Udy acknowledges this outlook now puts Capital Economics at odds with the broader market expectation - which still sees three rate hikes by May next year.
"If we are wrong and cases are brought under control in the weeks ahead, rate hikes in November and February are still on the cards," he says.
"But for now, that seems too optimistic to us."
Some bank economists have also updated their forecasts today but have stopped short of assuming a failure to eliminate and are still provisionally expecting rate hikes this year.
BNZ head of research Stephen Toplis makes a more moderate assumption around elimination.
"Let's assume the whole country stays in level 4 until August 31 but then drops to level 3," he says.
"Auckland stays at level 4 for four weeks until mid-September and then drops down the levels by one step each fortnight. The rest of the country also drops down the
levels, remaining one level below Auckland. The whole country is back in level 1 by mid October".
At face value, based on BNZ's latest models for the economic impact of lockdowns, "activity in the September quarter will fall around 7 per cent compared to June but then increase around 8 per cent in December, as the level of restrictions is lifted".
"The March quarter would have us back where we began," he says.
It would take a major demand slump to put a dent in inflation, Toplis says.
"For now, we remain with our view that the cash rate is raised in both October and November".