A troubleshooting item from Squid on getting WinXP WindowsUpdate to work with proxies instead of ignoring the user’s setting:
The problem was that WU did not go through the proxy and tries to establish direct HTTP connections to Update-servers. Even when I set the proxy in IE again, it didn’t help . It isn’t Squid’s problem that Windows Update doesn’t work, but it is in Windows itself. The solution is to use the ‘proxycfg’ tool shipped with Windows XP. With this tool you can set the proxy for WinHTTP.
C:\> proxycfg -p wu-proxy.lan:8080
# Set Proxy to use with Windows Update to wu-proxy.lan, port 8080
c:\> proxycfg -u
# Set proxy to Internet Explorer settings.