I'm also getting this with lspci:
Network controller: RaLink RT2561/RT61 802.11g PCI

I have change the /etc/network/interfaces file as above, but I still
have to disable/enable the connection from within System Settings.

This card was working fine with Kubuntu 7.04.

Have tried using Knetworkmanager, but that doesn't seem to connect
automatically.

-- 
bug wifi rt61 gutsy
https://bugs.launchpad.net/bugs/144239
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