It's not really a solution, but I've found that if I press the "windows" key, the combat gets resolved as I go out to the desktop, then when I click on the game in the taskbar I'm able to play it again. Yeah, a horrible clumsy workaround, but it is technically possible to play. A real solution would be great, though.
I don't know would my suggestion be helpful, but I have resolved described problem this way:
1. I've downloaded and installed the following update 1.20 Link
2. I've do the following:
a) put a galciv.exe file(not a gcmenu) to the desktop of my Windows 7 as a shortcut;
b) select it with the right mouse button and choose "Settings" then "Compatibility" tab
c) there should be chosen a "Windows 98/Windows ME" compatibility and the mark of administrator rights should be set, press "Apply" then "OK"
3. Run the game with this freshly generated shortcut and start a scenario then go to "Options" and set "Show player battles" and "Show AI battles" to OFF
It works fine for me on Windows 7 x32 bit and there is no issues described above.
I play not an Altarian Prophecy, but an Expanded Universe expansion.