There's  a comprehensive knowledgebase article on "How to configure Windows XP Service Pack 2 (SP2) for use with SQL Server" on the Microsoft website. Sure enough, when I installed SP2 on my laptop I could no longer access the Sql Server instance installed on my laptop for developing purposes.

The first thing to do to resolve this issue is fiddle with it yourself. At least, that's what I did. Opening up port 1433 in the firewall didn't do the trick. Reverting to named pipes didn't work either. But when I changed the connectionstring from "server=localhost;..." to "server=(local);..." all troubles went away (well, not all of course, but the Sql Server connection issue anyway).

While writing this post, I tried to find out what the technical difference is between localhost and (local), but I could find any info on this. People seem to be using either one randomly. If anyone knows the difference I would be pleased to know.