Possibly during the initial update process something went crazy and corrupted the registry and possibly the files that are used and modified during this process might have been corrupt as well. I usually use ERUNT in between application installs and Windows updates so if something goes wrong and the cause is a corruption in the registry, reverting back with Erunt solves the issue. Or, Windows System Restore...

With Windows update, there is no telling what will break and when. If this is not a brand new system that you had XP installed and were able to run updates just fine, then I say why bother troubleshooting it, start from scratch again. Even if you found the cause and fix it, chances are, it or something else will break again down the line...

I don't blame you for doing the updates manually, I am the same way. I was staying away from IE7 but on one of the systems I did accidentally installed it but it is running pretty good. I think they worked out bunch of functionality and security bugs in it, so it seemed much better than the last time I tried it (like a year ago).