1. CrystalBall© sez...

Updates are not installed successfully from Windows Update, from Microsoft
Update, or by using Automatic Updates after you repair a Windows XP
installation:
http://support.microsoft.com/kb/943144

NB: Also applies to clean installs, upgrade installs, and Recovery installs.

2. Required reading IMHO before installing IE7:

Sandi's Installation Tips <= Steps #1-8, #10 & #11; take note of #12, then
STOP!
http://www.ie-vista.com/known_issues.html#pre-install
(ignore any references to Vista)

And I strongly recommend using
http://www.microsoft.com/windows/downloads/ie/getitnow.mspx as the
installation source, not Automatic/Windows Update.

Alternately, use this Direct Download link:
http://www.microsoft.com/downloads/details.aspx?familyid=9ae91ebe-3385-447c-8a30
-081805b2f90b

Tip: Save the installer to your desktop, do not Run it.

Make *certain* that you check in at Windows Update immediately after
installing IE7 and install any critical updates offered.  If Optional
Updates category offers Root Certificates update, I recommend installing it
to take full advantage of IE7's additional security.

IEBlog : IE7 Installation and Anti-Malware Applications
http://blogs.msdn.com/ie/archive/2006/10/11/IE7-Installation-and-Anti_2D00_Malwa
re-Applications.aspx

What's New in Internet Explorer 7
http://msdn.microsoft.com/en-us/library/ms649487.aspx

Release Notes
http://msdn2.microsoft.com/en-us/ie/Aa740486.aspx

IEBlog: IE and Windows XP Service Pack 3
http://blogs.msdn.com/ie/archive/2008/05/05/ie-and-xpsp3.aspx