Fixed it with this.
Can't activate Windows XP after a repair install or in-place upgrade
Tuesday, March 9th, 2010
Windows XP is a picky beast. If you want to move it from one system to another, chances are that you'll just get a BSOD upon boot. To get around this, you can do a repair install or "in-place upgrade" to convince it to take stock of all of the new hardware and then it will probably boot up fine. Of course, there's other reasons to run a repair install, it might be able to save a system that isn't working because of a strange configuration problem or a malware attack.
Anyway, here's something that I've run into a few times now: After running a repair install using a Windows XP SP3 disc, after booting up and logging in, you're given the message along the lines of: "You must activate Windows before you can log on. Would you like to activate Windows now?" If you select "Yes," which is supposed to bring up the activation prompt, nothing happens. You get to stare at your desktop wallpaper until you decide to restart your computer manually. If you select "No," you are immediately logged out. What to do?
Anyway, I discovered an easy solution to this problem today: Just boot the machine in safe mode and install Internet Explorer 8. (You'll need to download it from Microsoft's web site and put it on a flash drive or something to move to the troubled machine.) After IE8 is installed, reboot again in normal mode and you should be able to activate. Note that you still may have to wait a minute or so for the activation window to appear after you click "Yes."
This condition may be dependent on having IE8 (or 7?) installed before you attempt the repair install, and it somehow gets messed up during the install.
Update: September 18, 2010
If you are having trouble installing IE8, make sure that you have Windows XP Service Pack 3 installed. Some commenters below have reported trouble getting IE8 to install without an Internet connection to download the updates that it wants (since you are in safe mode) and without SP3.
Update: May 11, 2011
If you boot into safe mode and get a message that you need to activate Windows, make sure that you did not select Safe Mode with Networking. You need to be in plain old Safe Mode to be able to log in.