Just to add to your woes and to add a bit of diversity. I would like to
point out that this does not only apply to Ubuntu as VM on a Windows
host.

I have exactly the same problem with Lucid, running under VM Fusion on
Mac OSX. Interestingly, i only built this machine today and only had
this problem once i updated the machine. I built the initial VM using a
beta1 ISO and everything was wonderful.

Unfortunately i have not been one of the lucky ones and been able to use
the onscreen keyboard to login. I have no way to log in whatsoever, the
keyboard does not come up if i try using the onscreen keyboard. No
matter what i do the minute i tick the box, it disappears.

-- 
keyboard input broken at gnome login prompt after package updates
https://bugs.launchpad.net/bugs/548891
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