In manufacturing industries, the need for tighter tolerance in part production demands greater capability in the machine tools. Expensive unplanned downtime, requiring ordering of new components with long lead-times is often attributable to the main spindles and, the bearings. Modern engineering systems use precision measurement systems for analysing machine tool errors. Large scale business enterprises use expensive measurement systems for measuring the dynamic error in spindles. For small and medium-sized enterprises, there are no system sufficiently affordable that has the requisite performance capability. One commercial system, developed by IBS Precision Engineering, is designed for installation on a machine for rapid regular measurement but, relative to the value of the average machine tool, is also expensive being up to 25% of the machine value. The primary objective of this research is to develop a low-cost sensor technology capable of measuring spindle error motion with high precision. To achieve this, various displacement sensing approaches were investigated, leading to the design of a novel spindle error measurement system based on ultra-low-cost slotted photo microsensors. As this type of sensor has not previously been characterized for displacement measurement, a dedicated calibration procedure was conducted on the prototype system to establish its performance and reliability. With any spindle error measurement system, it is necessary to separate spindle error motion from the artefact form error. Donaldson reversal is prominent method used for error separation. This research also proposes a digital reversal to avoid complex manual reversal. The simulation results showed that prominent random external effects besides the test bar error were separated completely while most of the system effects has been reduced to 50%. Initially, a single-pair SPM system was designed to evaluate the effect of thermal error in a machine tool spindle during high-speed rotation. The sensor system was compared to the traditional NCDT eddy current sensor used for this purpose. Both the SPM sensor and the conventional NCDT eddy current sensor recorded thermal inaccuracy with a 2 μm variation. By the combination of differential measurement, arrangement of sensor modules and signal conditioning, this research developed a prototype that can measure radial error motion test bar. The validation of the system was conducted in comparison with the commercially available system for high rotational speed of up to 12000rpm. The SPM sensor system measured comparable results with the commercial system, the lowest difference in standard deviation of 0.005 μm for the total error motion was observed. The FFT analysis indicated the capture of most of the bearing frequencies in comparison with the traditional measurement system.