Solution is to filter through cmd.exe /c "type %1". cmd's type builtin will do the conversion, and so you can use that with the textconv ability of git diff to enable text diffing of UTF-16 files (should work with UTF-8 as well, although untested).
Quoting from gitattributes man page:
==============================
Performing text diffs of binary files
Sometimes it is desirable to see the diff of a text-converted version of some binary files. For example, a word processor document can be converted to an ASCII text representation, and the diff of the text shown. Even though this conversion loses some information, the resulting diff is useful for human viewing (but cannot be applied directly).
The textconv config option is used to define a program for performing such a conversion. The program should take a single argument, the name of a file to convert, and produce the resulting text on stdout.
For example, to show the diff of the exif information of a file instead of the binary information (assuming you have the exif tool installed), add the following section to your $GIT_DIR/config file (or $HOME/.gitconfig file):
[diff "jpg"]
textconv = exif
==============================
A solution for mingw32, cygwin fans may have to alter the approach. The issue is with passing the filename to convert to cmd.exe - it will be using forward slashes, and cmd assumes backslash directory separators.
Step 1:
Create the single argument script that will do the conversion to stdout. c:\path\to\some\script.sh:
#!/bin/bash
SED='s/\//\\\\/g'
FILE=\echo $1 | sed -e "$SED"\
cmd.exe /c "type $FILE"
Step 2:
Set up git to be able to use the script file. Inside your git config (~/.gitconfig or .git/config or see man git-config), put this:
[diff "cmdtype"]
textconv = c:/path/to/some/script.sh
Step 3:
Point out files to apply this workarond to by utilizing .gitattributes files (see man gitattributes(5)):
*vmc diff=cmdtype
then use git diff on your files.