1) "I have written a bootloader program to sit on the P89C664 processor" why not use the ROM based bootloader?
2)"if I then try to user a timer interrupt" is the interrupt enabled and processed by the bootloader ? (it is disabled on reset)
3) "use the onboard watchdog, but this is automatically disabled during flash operations" why use a watchdog during programming, you have no meanss of restarting after reset - the very purpose of a watchdog.
4)"Does anybody know of a way to prevent this problem" I have e-mailed you my solution.

Have fun,

Erik

PS Throw away WinIsp, download FlashMagic from www.esacademy.com FlashMagic is paid for by Philips, I do not understand why they keep promoting the inferior WinIsp.