Confirmed here, tested with python2.6 
on Linux with sys.stding.encoding == 'ISO-8859-1'
on Windows with sys.stdin.encoding == 'cp437'

>>> import sqlite3
>>> db = sqlite3.connect(':memory:')
>>> cur = db.cursor()
>>> cur.execute("create table foo (x)")
>>> cur.execute("insert into foo values ('café')")
>>> cur.execute("select * from foo")
Traceback (most recent call last):
  File "<stdin>", line 1, in <module>
sqlite3.OperationalError: Could not decode to UTF-8 column 'x' with text
'café'


It seems that sqlite3 expects strings to be utf-8 encoded.
It works fine if you pass unicode strings, and with python 3.0.