Python 2.7.2 and Google App Engine SDK 1.6.1 on Win 7 Home Premium not working
I had a similar issue; it turned out my problem was not due to environment variables.
Debugging GAE:
First off let me say that if you are having problems with GAE, I would strongly recommend launching using the CLI, google_appengine/dev_appserver.py.  There is a large stack trace of the reason GAE is failing (instead of simply a red link in the GAE Launcher GUI) that will point you in the right direction.
Hidden bad characters:
When copying the text from google's "hello world" tutorial, there was an invisible hidden character at the start of my YAML file (I found it using kdiff, a diff tool).  After deleting this character, my app launched (and showed up as not red in the GAE Launcher GUI).
Environment Variables:
As to your original question, the only relevant environment variable I have set is my PATH variable, where I have appended the folder of my python executable (in my case C:\Python27) so that I can run python files without specifying the full path to Python.  Let me repeat, however, that I do not believe this is the cause of your problem, but you can more directly confirm this using the CLI.
I have installed Python 2.7.2 (Win7 32-bit) and Google App Engine SDK 1.6.1 for Win7 on a 64-bit system running Win7 Home Premium.  Default folder locations for both Python and GAE.  When I try to run the helloworld project as described in the Google Python Getting Started doc, the Launcher's "browse" button never becomes active.  The GAE SDK is supposed to do fine with Python 2.7.
Is there a complete listing anywhere of environment variables needed for this setup to work?  So far, all posts I have seen are from users who have gotten well past this absolutely basic step.