I'm setting up a computer and am just curious if Windows XP Mode can become infected with a virus that will harm the Windows 7 host?
Yes it is possible but not for the argument of the virus file is into the host filesystem, that is very unlikely possible.
The separation is the same in XP Mode or VMware Workstation for the virtualization architecture.
It is possible though, and much more in XP Mode than other virtualization technologies because XP Mode maps the real file system to the VM. In fact if you use an app in XP Mode and using that open the documents folder, you will see your host OS documents, not the VM folder. This was done to give the user a better experience.
Microsoft recommends to have an antivirus installed in XP Mode. Microsoft Security Essentials is supported and works like a charm in XP Mode.