Yeah I have been having problems with this since, hmm.. well dont really know...
I am using zenphoto version 1.0.8 on my own site.. and zenphoto version 1.1.3 for few others... they all have a working charset with Icelandic letters.
So... this problem has been for a very long time and I have talked about it many times, and never really gotten answers if this will be fixed... I can gladly give you a photo that has these characters to try out.
As for a long time ZenPhoto has been unusable to me, because of this problem... I know charsets are a pain in the b*** and I have never understood why companies could not just settle for 1... that is UTF-8
I am hoping for a fix soon, as I am myself completely empty on the matter as it is now.