you should be booting to the HDD...at that point in the setup...
Try this: boot the the XP CD, delete and recreate the boot partition, do a full format instead of a quick, and have it go through the setup again, when it reboots make sure you go to the HDD. make sure you clean the Xp CD real good to eliminate any issues there. If this doesn't work, get the manufacturer HDD diagnostics and test the HDD fully to be sure it is not defective. When it reboots you could try to pull the XP CD out of the drive just long enough to make sure it does boot to the HDD and then put it back in...hmmm try that and let me know how that goes.