CERT Recommends SP2

The U.S Computer Security Response Team has recommended that all users install Service Pack 2 for Windows XP.
http://www.us-cert.gov/cas/alerts/SA04-243A.html
Reasons:
Windows Firewall
Windows Firewall is enabled in almost all configurations, blocking network traffic coming into your computer. Blocking this traffic helps to protect you from worms and other malicious code that spread via the Internet.
Internet Explorer Local Machine Zone Lockdown
New settings for Internet Explorer disable the execution of ActiveX controls and Active scripting in the Local Machine Zone. This protects you from attacks and vulnerabilities such as Download.Ject.
Additional Internet Explorer Security Changes
Internet Explorer now includes a pop-up blocker, additional window restrictions, and changes in MIME type handling that better defend against social engineering and “phishing” attacks. A browser add-on management interface provides a way to identify and disable programs that run as part of Internet Explorer. Enhanced protection against security zone elevation and object caching vulnerabilities helps defend against malicious web scripts.
Email Handling Technologies
Outlook Express now supports the ability to read and compose messages in plain text and to block external HTML content such as “web bugs.” Security checks are now performed in a more consistent way to help prevent the execution of malicious attachments.
Security Center
The Security Center “…provides a central location for changing security settings, learning more about security, and ensuring that [your] computer is up to date, with the essential security settings that are recommended by Microsoft.”
Automatic Updates
The update services and automatic update feature of Windows XP have been improved. US-CERT highly recommends that you enable Automatic Updates.
Data Execution Prevention
Memory protection helps prevent attackers from executing code on your computer.