I have a file with Swedish characters in it (åäö) encoded with UTF8.
If I cat the file it displays fine, but if I do git diff the special c
cat
git diff
git is dumping out raw bytes. In this case, it doesn't care what your file's encoding is. The highlighted you're seeing is coming from less, which is presumably configured as your PAGER. Try setting:
git
less
PAGER
LESSCHARSET=UTF-8