Paulmancan2,
I just ran into this problem today and thought I would share the solution with you (or at least what worked for me.)
Windows auto update attempts to locate an auto proxy server to determine the proxy settings it should use. If no auto proxy server is found, it assumes no proxy. It completely ignores the proxy settings in IE. Because my installation uses a proxy, I had to set the proxy in the registry key that auto update uses. Following is how to check it and set it if needed:
To EXAMINE the proxy settings used by auto update:
C:> proxycfg
To DELETE all proxy settings in this registry key:
C:> proxycfg -d
To SET a proxy for autoupdate:
C:> proxycfg -p your-proxy-goes-here.com:port#
I recommend that if this approach is for you, delete previous settings before setting new ones.
Also note that you must stop the auto update service and restart it before the changes take place. The whole sequence would look like this:
To STOP the auto update service:
C:> net stop wuauserv
C:> proxycfg -d
C:> proxycfg -p thisismyproxy:8080
C:> net start wuauserv
By running SQUID, you're supplying a proxy for auto update to use.
Hope this helps you and any others that may experience the same issue.