OK. Solved. So the steps to install XP SP3 from an ISO disk image using are;
1. Install refit on your disk. Installing rEFIt
2. Partition your disk using Bootcamp.
3. On a windows machine/or a virtual machine transfer the ISO contents to a USB disk using win2flash software.Download
(virtual machine can istall from ISO images directly. If you are using a windows machine you'll need a software to mount ISO image. Microsoft has an unsupported one on their web site. Virtual CD-ROM Control Panel for Windows XP)
4. Boot your Mac and selct the USB drive from the Refit menu at the startup.
5. Select Text based install and when the installer restarts elect the USB disk again and select partition 3 from the startup selection menu.
6. Now Mac boots from bootcamp partition and continues the installation. When the installer finishes and computer reboots select USB disk first and later partition 3 again.
7. When the reboot finishes go the My Computer right click properties Settings > Start up and recovery tab, sytem startup -> edit (or directly edit boot.ini in C:) http://support.microsoft.com/kb/289022 to change the partition(1) to partition(3) in two places to correctly point to bootcamp partition.
8. Install Bootcamp drivers. You could copy them to the USB drive in step 3 to make things easier.
At least that's how I managed to install XP without a CD drive.
I followed your steps above, but got stuck on #5. I ran the text-based installer, and after it had finished copying XP onto Partition 3, it restarted. Then, when rEFit came back on the screen, I chose the Partion 3 XP, and received an error message: "Disk error. Press any key to restart."
Did I mess up somewhere?