Try removing both the set encoding and set fileencoding lines. And see if it does what you want. It should do latin1 still by default (based on your system settings), and still let you see utf files. If that fails, leave the 'set encoding', but leave out the 'set fileencoding'. I think that you only need a fileencoding line when you want to force conversion. Otherwise 'set encoding' does the trick.
I had this problem too, when I WANTED to set everything to utf-8. Scot
