a workaround for your issue (fancybox 1.2.1) is
1. edit your fancybox.js file (no pack)
2. around the line 30 find:
var isIE = ($.browser.msie && parseInt($.browser.version.substr(0,1))
< 8);
3. change the last value (8) to 7 so you get
var isIE = ($.browser.msie && parseInt($.browser.version.substr(0,1))
< 7);
NOTE: if you want the same effect for IE6 then set the value to 6 BUT
your fancyclose (png) button won't be transparent - you may need to
edit it (photoshop or gimp) and save it as gif and make the proper
changes to your css file
4. save your js file and optionally go to your html file
5. optional - I saw you have edited the fancybox css file but be sure
to set:
div#fancy_bg {display: none;}
div#fancy_content,
div#fancy_inner,
div#fancy_outer {background-color: transparent; background-image: url
(); border: 0;}
6. optional: set fancybox 'padding' to 0 (zero) to align the
fancyclose button
further reading about this issue:
http://groups.google.com/group/fancybox/browse_thread/thread/fef8b7a41ab476c8/9dafe9858f2c1965