Had a moment of confusion when upgrading to XCode 3.2.3. That version seems to support only iOS3.2 (iPad) and iOS4. Tried using previous XCode 3.1.3 for developing iOS3 software, just to get frustrated by non-backwards compatibility issues.
Use latest XCode 3.2.3. Set project Base SDK as iPhone Device 4.0 and iPhone OS Deployment Target as iPhone OS 3.0 - or anything as far backwards as iPhone OS 2.0.