Thanks. I never intentionally changed the system locale but it is fixed now. 
For those who are interested, this is how you do it. Change in
  /etc/default/locale
the line
  LANG="en_US.iso88591"
to
  LANG="en_US.utf8"
and all new shells will automatically use this locale

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https://bugs.launchpad.net/bugs/1089302

Title:
  psql client by default in LATIN1 while should be UTF8

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