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There is no reason Premiere Elements 7 shouldn't work with XP SP3, John.
Just make sure you go to Windows Update and get all of the updates (click the Custom button) as well as the latest RealTek drivers for your system and the latest version of Quicktime.
Nothing makes this program go buggy like outdated firmware, drivers and especially Quicktime! (Well, assuming you've got ample hardware and you're editing standard video formats, of course.)
And keep your system well maintained!
I do recall some folk having a few issues with MCE and Adobe Premiere Pro at about CS2. That would have been an earlier SP version of MCE, than you probably have, and also was with P-Pro. Have not heard of any problems with any version of PE and MCE.
Make sure that you follow Steve's advice.
If you upgrade to SP3 you can uninstall it later if you don't like it. Not something I have done, so don't know what gotchas there might be.