This latest controversy comes on the heels of mass protests last month that forced the prime minister to abandon his plans for labour reform in an embarrassing back-down.
"Nothing will distract me from my duty as prime minister, at the service of the French people," Mr Villepin said in response to suggestions he could be forced to stand down over the allegations.
In parliament the embattled prime minister defended himself claiming he had been "the victim of a terrible campaign of slander and lies," linking him to a shadowy corruption case.
Race for the presidency
Mr Villepin and Mr Sarkozy both wish to succeed President Jacques Chirac when his presidential term ends next year.
This latest scandal along with his back down on labour legislation has been a massive set-back to Mr Villepin’s chances in next year’s presidential election.
Poll numbers give Mr Villepin the second-lowest rating of any French prime minister in 40 years, and Mr Sarkozy is considered a far more popular candidate.
False claims
On Friday, the French daily Le Monde reported that Mr Villepin had asked a high-ranking French spy to investigate Mr Sarkozy.
It was part of a long-running probe involving a fabricated list of bank accounts and defence contracts.
The paper reported that in 2004, when Mr Villepin was Foreign Minister, he ordered General Philippe Rondot, a Defence Ministry intelligence adviser, to investigate allegations that French nationals had received corrupt payments.
The article suggested that Mr Villepin wanted Mr Sarkozy investigated.
Mr Villepin admitted that he ordered a discreet intelligence inquiry into rumours of corruption in the deal, but that: "At no time was Nicolas Sarkozy mentioned in that conversation."
General Rondot also denied that Mr Sarkozy’s name had come up at the time and said his comments in Le Monde's report, were taken out of context, and denies he was told to probe Mr Sarkozy.
The claims turned out to be false but Mr Sarkozy's camp has rounded on Mr Villepin accusing him of ordering an intelligence probe and failing to clear the interior minister’s name after the accusations proved to be fabricated.