This study mainly developed an error compensation system which can be applied to reduce the thermal expansion error of the spindle of a CNC machine tool. Temperature variations at 5 locations on the spindle were measured by PT-100 thermal sensors and self-designed electric circuit, and the deviations of the spindle in x, y and z directions due to thermal expansion were measured by high precision displacement sensors. Based on the measured temperatures and deviations, a regression mathematic model was calculated and implanted into the PIC chip to form a system for on-line thermal expansion monitoring system. When a machine tool is working, PT100 sensors can on-line measure the temperature variations of the spindle and feedback to the monitoring system to predict the thermal expansion of the spindle. The predicted expansions are then outputted to CNC controller for error compensation through an optical coupling circuit. The experimental results have shown that the system can effectively reduced the thermal expansion error from 40m to less than 10 m.