Rob Tiffany wrote an interesting article about encrypting data in Windows Phone 7. I'm not sure whether this is useful, since every application has its own isolated storage and different applications can't access each other's files. Access to the files is not permitted at all (even through the computer). I don't kwow what will happen with the phones which have a storage card. It's a mystery whether the applications will use the storage card as isolated storages, and will you have access to the files, when you put the card in your cardreader.
Either way, it's always good to encrypt all the confidential data. Since we don't know if it's necessary to encrypt the data, the best practice will be to encrypt the confidential data.
You can read the full article here.