Unicode character escape sequences instead of text upon mouse-2 paste from other windows

Question

I am having a weird problem with emacs:

When pasting non-ascii text, e.g. € from X-clipboard with the middle mouse button into x-enabled emacs I get Unicode character escape sequences, e.g. \u20ac instead of €.

If, however, I first do a "Copy" in the other window and then do C-y in emacs window, the text is inserted verbatim.

How can this be fixed?

Note: this behavior is not observed when pasting with the middle mouse button into emacs running inside xterm, that is in xterm pasting is fine both ways, with mouse and with C-y.