WindowsXP will use up to 12% of the disk space on drives over 4 Gigabytes, and 400Mb on drives smaller than that.
From that you can see that on say, an 80 Gigabyte drive the system restore files could occupy as much as 9.6 Gigabytes of disk space, so a limit of 1 Gigabyte is actually quite small for a big drive. There's no harm in allowing Windows to manage the restore file size on a big drive - most people will never fill these big hard drives anyway.
I've no idea why Windows should be ignoring your limit, which in the case of your drive seems reasonable to me, but it obviously is. What happens when you set no limit, but allow Windows to manage the disk space?