I can confirm that.
Especially without cursor keys it is in practice unusable.
I don't know, if the Problem is only in Karmic and not in previous
releases, but in Karmic YES.
--kapetr
** Changed in: xorg-server (Ubuntu)
Status: New => Confirmed
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Xephyr keyboard layout broken since Karmic upgrade
https://bugs.launchpad.net/bugs/469335
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