BUG #2319: psql utf8/latin1 client_encoding bug when using '-c'

The following bug has been logged online:

Bug reference:      2319
Logged by:          Mattias Kregert
Email address:      mattias@kregert.se
PostgreSQL version: 8.1.0
Operating system:   Linux 2.4
Description:        psql utf8/latin1 client_encoding bug when using '-c'
Details:

Psql '-c' does not work when using client_encoding.

Example:
Server has encoding UTF8, client has encoding latin1

-- This works...
% psql -h server mydb
mydb=# set client_encoding to 'latin1';
mydb=# select * from mytable where text='ÅÄÖ';

-- ...but this does not.
% psql -h server mydb -c "set client_encoding to 'latin1'; select * from
mytable where text='ÅÄÖ';"
ERROR:  invalid UTF-8 byte sequence detected near byte 0xc5

I tried this too, without success:
% psql --set encoding=latin1 -h server mydb ...