What worked for me, with a similar Update Manager loop (Win XP):
(PC had been running ok, then Installer/Update Manager started asking for a disk;
I did nothing to cause this error. Appears to be looking for ISUS.msi but giving it new ones didn't help.
Couldn't figure out what program it was trying to install.
It appears registry keys may have gotten corrupted during last update.)
Program Install and Unistall Troubleshooter
http://support.microsoft.com/kb/2438651
Program Install and Uninstall troubleshooter
(Replaces The Windows Installer Cleanup utility (MSICUU2.exe) )
http://support.microsoft.com/mats/Program_Install_and_Uninstall
Ran Fix It ... Problems Installing ... Update Manager
Rebooted
This appears to have fixed it
Ran MS Update to see if it still works ... OK