I've run XP with 1GB of RAM and with 2GB of RAM and can state that many modern games run far better with 2GB than 1GB. You get faster level loading, less stuttering in games, etc. For a lot of modern games now such as Bioshock, 1GB is the minimum requirement with 2GB being recommended. Plus RAM is hardly expensive...
CPU wise, at lower price points then there's little between Intel and AMD other than Intel's CPUs being more overclockable. True Intel's higher-end chips leave AMD well behind at the moment, but for a £100 or less CPU, both are worth considering if you're not planning on overclocking the system.
My advice would be to go for 2GB of RAM, a mid-range mobo (say £50-£75 or so) and then look at getting the best CPU you can with what's left. Don't forget that you may also need to replace your power supply if your old one doesn't have the newer 24pin ATX plug on it.
I'd agree with sticking with XP for now personally though.