Lula lost his right-hand man and chief of staff, Jose Dirceu, who was accused of being the "chief of corruption" in a cash-for-votes scandal.
But Brazilian polls say Lula would win re-election if the vote was held today.
Dirceu, 59, left the post saying that he had clean hands and that he would fight the allegations in the Chamber of Deputies.
The accusation came from the former leader of the Labour Party, Roberto Jefferson. Jefferson alleges that Lula's Workers' Party had been paying $12,500 in monthly bribes to deputies in allied parties in exchange for support for passing bills.
"Go now, Jose. Go quickly if you don't want to make a defendant out of an innocent man," Jefferson had warned last week, referring to Lula.
But Jefferson made the accusations after he himself was accused of taking kickbacks in a separate scandal involving payments to managers of the state post office, Correios, and no proof has been provided to support them.
Whatever the outcome, the political drama has been playing out on the national TV network, Globo. The inquiry has provoked the same fervour as the Michael Jackson court case did in the US, with live updates even cutting into the sacred novelas or soap operas in primetime.
President Luiz Inacio Lula da Silva
rejects corruption accusations
Dilma Rousseff, 57, the former energy minister, was brought in to replace Dirceu.
Lula remains indignant over the accusations. "They don't realise who they are dealing with," he said.
"You don't play around with corruption because you can't smear people's names, bare them in front of society, and then prove nothing without anyone's begging for forgiveness."
"In the history of the republic, no government has done even 20% of what we are doing to counter corruption."
"In the history of the republic, no government has done even 20% of what we are doing to counter corruption"
Luiz Inacio Lula da Silva, Brazilian president
The accusations cut deep because the Workers' Party was seen as a beacon of transparency in a country dogged with a history of high-level corruption.
In 1989, Fernando Collor de Mello became the first directly elected president after the military dictatorship of 1964-1985. Popular hopes for a new future were extinguished when Mello fled to Miami in 1992 during a trial for his impeachment over missing billions from government coffers.
In opposition, Lula always stood as an ethical alternative. With a bid for re-election in 2006, the opposition are scenting blood.
But the resignation of Dirceu and his claim of innocence appear to have taken the wind out of their sails.
"I don't consider myself out of government," says Dirceu.
"Lula's government is my passion, it's my life, and in going I am leaving here a part of my heart as everyone knows. But I'm not leaving my soul. It is with me for the struggle," he said in his resignation speech.
Dirceu is widely credited with bringing the Workers' Party to power at the fourth attempt by creating alliances with opposition parties. He was a guerrilla during the dictatorship and even had plastic surgery to change his features when hiding in the south of Brazil before a political amnesty.
His replacement, Rousseff, is also a former guerrilla. In her swearing-in ceremony she drew attention to the sacrifices she and Dirceu made in the past.
"None of us who lived through the dictatorship can forget the fundamental value of democracy," she said.
But according to polls in the local media, Lula's credibility has not been affected. Only 14% of respondents believe Lula should go, with 41% saying there is no chance he will be impeached.
"None of us who lived through the dictatorship can forget the fundamental value of democracy"
Another 43% say it is too early to judge the scandal. He would win re-election if the election was held today, the polls said.
Even the originator of the mud-slinging, Jefferson, says Lula is not involved.
The parliamentary inquiry continues, with Dirceu expected to take the stand in a bid to clear his name and that of his party.
Lula is set to announce wide-ranging changes in an overdue cabinet reshuffle designed to rebuild the coalition damaged by the allegations.
Looking tired and strained, the president announced: "Now is the hour for everyone to understand that the government needs to change its face. We only have a year and a half left."
"No one has more moral and ethical authority than I do to do what needs doing in this country."