From the error message as given, it's not clear whether the problem is with the source document, the stylesheet, or the output document. Are there no other clues? (If not, another XSLT processor might give better diagnostics...).
My first guess would be that the problem is with the stylesheet itself, that you have edited it using an editor whose default encoding is iso 8859-1 but you haven't added an XML declaration at the start of the stylesheet to say so. See what happens if you add <?xml version="1.0" encoding="iso-8859-1"?>
Author, XSLT 2.0 and XPath 2.0 Programmer's Reference