On Windows Server 2003 I am using a web browser (http://servername/site) to get to a web site on itself (servername) referencing an entry in the hosts.txt file - required for the use of the software. I am receiving the user authentication box ('connect to') box. Verified that the integrated windows authentication is unchecked in the IIS properties.
I can access this web site (http://servername/site) successfully from another Windows Server 2003 and Windows XP with the hosts.txt entry. I can also access a web site (http://servername1/site1) from servername with the servername1 entry in the hosts.txt file.
From this I can see that servername is utilizing the hosts.txt file. For the IP address I tried both the actual address and the loopback (127.0.0.1) address.
Are you expecting automatic login to the site? If you have unchecked integrated Windows auth, what have you anabled? Is anonymous access allowed?
I found inconsistencies in IIS security at the site (anonymous) and virtual directory (integrated Windows) levels. Evidently, something triggered finding these when the web site was accessed with a host name from the same server but not found when an IP address (or requested from another machine - when the host was already converted to IP) was used.
When I changed them both to Integrated Windows security it worked fine.