diff --git a/hgext/highlight/highlight.py b/hgext/highlight/highlight.py
--- a/hgext/highlight/highlight.py
+++ b/hgext/highlight/highlight.py
@@ -32,26 +32,27 @@ def pygmentize(field, fctx, style, tmpl)
     if util.binary(text):
         return
 
-    # avoid UnicodeDecodeError in pygments
-    text = encoding.tolocal(text)
+    # Pygments is best used with Unicode strings:
+    # <http://pygments.org/docs/unicode/>
+    text = text.decode(encoding.encoding, 'replace')
 
     # To get multi-line strings right, we can't format line-by-line
     try:
-        lexer = guess_lexer_for_filename(fctx.path(), text[:1024],
-                                         encoding=encoding.encoding)
+        lexer = guess_lexer_for_filename(fctx.path(), text[:1024])
     except (ClassNotFound, ValueError):
         try:
-            lexer = guess_lexer(text[:1024], encoding=encoding.encoding)
+            lexer = guess_lexer(text[:1024])
         except (ClassNotFound, ValueError):
-            lexer = TextLexer(encoding=encoding.encoding)
+            lexer = TextLexer()
 
-    formatter = HtmlFormatter(style=style, encoding=encoding.encoding)
+    formatter = HtmlFormatter(style=style)
 
     colorized = highlight(text, lexer, formatter)
     # strip wrapping div
     colorized = colorized[:colorized.find('\n</pre>')]
     colorized = colorized[colorized.find('<pre>')+5:]
-    coloriter = iter(colorized.splitlines())
+    coloriter = (s.encode(encoding.encoding, 'replace')
+                 for s in colorized.splitlines())
 
     tmpl.filters['colorize'] = lambda x: coloriter.next()
 
diff --git a/tests/test-highlight b/tests/test-highlight
--- a/tests/test-highlight
+++ b/tests/test-highlight
@@ -121,3 +121,28 @@ rm out
 
 echo % errors encountered
 cat errors.log
+
+cd ..
+hg init eucjp
+cd eucjp
+
+printf '\265\376\n' >> eucjp.txt  # Japanese kanji "Kyo"
+
+hg ci -Ama
+
+hgserveget () {
+    "$TESTDIR/killdaemons.py"
+    echo % HGENCODING="$1" hg serve
+    HGENCODING="$1" hg serve -p $HGPORT -d -n test --pid-file=hg.pid -E errors.log
+    cat hg.pid >> $DAEMON_PIDS
+
+    echo % hgweb filerevision, html
+    "$TESTDIR/get-with-headers.py" localhost:$HGPORT "/file/tip/$2" \
+        | grep '<div class="parity0 source">' | $TESTDIR/printrepr.py
+    echo % errors encountered
+    cat errors.log
+}
+
+hgserveget euc-jp eucjp.txt
+hgserveget utf-8 eucjp.txt
+hgserveget us-ascii eucjp.txt
diff --git a/tests/test-highlight.out b/tests/test-highlight.out
--- a/tests/test-highlight.out
+++ b/tests/test-highlight.out
@@ -538,3 +538,16 @@ 200 Script output follows
 /* pygments_style = fruity */
 
 % errors encountered
+adding eucjp.txt
+% HGENCODING=euc-jp hg serve
+% hgweb filerevision, html
+<div class="parity0 source"><a href="#l1" id="l1">     1</a> \xb5\xfe</div>
+% errors encountered
+% HGENCODING=utf-8 hg serve
+% hgweb filerevision, html
+<div class="parity0 source"><a href="#l1" id="l1">     1</a> \xef\xbf\xbd\xef\xbf\xbd</div>
+% errors encountered
+% HGENCODING=us-ascii hg serve
+% hgweb filerevision, html
+<div class="parity0 source"><a href="#l1" id="l1">     1</a> ??</div>
+% errors encountered