Select by Location geoprocessor not working

I am trying to use the 'Select Layer By Location' tool to select one point layer where it intersects with another point layer (so where one point is in the same location as a point in the second layer). When I use the 'Select by Location' option from the Selection menu, this works correctly and selects 3802 records.

However when I try to use the 'Select Layer By Location' tool from ArcToolbox (or from the Python window, or using a python script directly) nothing is selected at all. The tool says it completed successfully, but nothing is selected.

Here is what is in my Python window:
The input and selection layers are layers within my ArcMap.

Am I doing something wrong, or using the tool incorrectly? I find it odd that it works from from the Selection menu dialogue, but not from the tool.

I'm running ArcMap 10.1 SP1.

Thanks,
Mike.