It is true that this 'action' seems deliberate by microsoft, and that in
their eyes they haven't messed up, but have deliberately enhanced their MS
Live services and functionality. The thing about microsoft they are not very
forward at coming forward and so I guess we will not know if this is a
mistake or genuinely deliberate by them.

I say that it seems deliberate because all of my PC, which all worked fine
by automatically logging in when connection to internet is achieved, all
started with this same problem. That tells me that the issue of 'forgetting'
the display name is not hat of the local PC, and more intended by he
messenger service network.

As I have found, and suggested in the profile setup, it is the FIRST name
that is publicly displayed and therefore the first name that appears on the
chat box. As you have seen, it is therefore recommended (by me :-) ) to set
the first name as your nickname that you want displaying. For me, who wants
or needs you fullname in the profile anyway?! (Dont answer. Of course I know
SOMEONE will).

(I find it amusing that I came on searching for an answer myself for the
problem, just to workout the answer myself and post it to help others)