Windows 98 really should be on the first partition, and should be installed before Windows XP. Microsoft's Knowledge base article 306559, "HOW TO: Create a Multiple-Boot System in Windows XP" describes the process. If you really insist on keeping your existing installation however, instead of doing the sensible thing by backing up and starting over again, here's a procedure that I've seen reported to work.
Start off by making sure the FAT32 partition you are going to use is set to 'Active'.
Copy the Windows 98 .cab files (contents of the \win98 directory of the CD) to \windows\options\cabs on the new partition.
Boot the computer with a Windows 98 boot disk, and install Windows 98 from that directory.
Then use your Windows XP CD and start installation by running 'Setup' from within Windows 98.
When you are prompted to reboot, reboot back into Windows 98 instead of into Windows XP setup.
Edit the Boot.ini file on the Fat32 partition from:
C:\$WIN_NT$.~BT\BOOTSECT.DAT="Microsoft Windows XP Home Edition Setup"
Default=C: [Operating Systems]
C:\="Microsoft Windows 98 Second Edition"
multi(0)disk(0)rdisk(0)partition(1)\windows="Microsoft Windows XP Home Edition"
You can delete the $win_nt$.~bt directory afterward.