A spokesman for the Islamic Party, Iyad Samarrai, said top party officials had met earlier in the day with Prime Minister Iyad Allawi to demand he stop the Falluja offensive and try to negotiate a peaceful settlement with fighters there.
When the talks failed, the party saw no justification to remain a part of the interim government and subsequently quit.
The party's only member to hold a ministerial post abandoned the group, however, to keep his government position.
"The Islamic Party made the decision to withdraw from the government because of the military offensive in Falluja, but I don't share this opinion and decided to quit the party and remain in my post," said Minister of Industry Hashim al-Hasani.
"To withdraw would not serve the interests of the Iraqi people."
US-led forces have moved deep into Falluja since launching a major assault to retake the city on Monday, as the US-backed government struggles to restore order before national elections planned for January.
Calls for boycott
Earlier, the Association of Muslim Scholars (AMS) an influential Iraqi group, urged Iraqi security forces not to fight alongside US troops storming the besieged city of Falluja.
"We call on the Iraqi forces, the National Guard and others
who are mostly Muslims to beware of making the grave mistake of invading Iraqi cities under the banner of forces who respect no religion or human rights," the AMS said in a statement on Monday.
"Beware of being deceived that you are fighting terrorists from outside the country, because by God you are fighting the townspeople and targeting its men, women and children and
history will record every drop of blood you spill in oppressing the people of your nation," the AMS said.
The AMS has threatened to call for a boycott of the poll if assaults on cities in Iraq's Sunni heartland escalate.