Jailed former Brazilian president Luiz Inacio Lula da Silva (photo) will step aside on Tuesday so his running mate can stand for the presidency in next month's election, party sources said, as leftist candidates' strong showing in a poll pulled markets lower.

Lula, by far Brazil's most popular politician, hoped the Supreme Court would agree to an appeal for more time to switch the head of the Workers Party (PT) ticket after the top electoral court last week banned him from running due to a corruption conviction and gave him 10 days to remove his name.

Two sources with knowledge of Lula's decision said Fernando Haddad will become the official PT candidate with an announcement outside Federal Police headquarters in the southern city of Curitiba, where the leftist icon has been jailed since April, serving a 12-year sentence for receiving bribes.

Despite appeals pending before the Supreme Court, Lula decided it was time to pass the baton to Haddad on the deadline set by the court and not run the risk of votes for his party's ticket being annulled by the electoral court.

Lula, who controls the PT he founded and determines its election strategy from his jail cell, has kept his candidacy alive for as long as possible, hoping to maximize the transfer of votes to Haddad, a former Sao Paulo mayor who is barely known in many parts of Brazil.

A Datafolha poll conducted on Monday showed that transfer has begun. While still in the single digits, support for Haddad increased from four to nine percent, the biggest gain among the 13 candidates running for president.

The same poll also showed strengthening support for another leftist, Ciro Gomes, a former governor and finance minister, whose support rose to 13 percent from 10 percent.

Market favorites who say they will continue President Michel Temer's economic reforms had few gains, adding to investor anxiety.

The Datafolha survey showed far-right law-and-order candidate Jair Bolsonaro, who was the top vote-getter in first-round scenarios, increasing by 2 percentage points to 24 percent, less than many expected after he survived a near-fatal stabbing last week.

Former Sao Paulo Mayor Geraldo Alckmin, a center-right candidate, ticked up just one percentage point to 10 percent. Monday's poll confirmed previous surveys showing Bolsonaro would lose to every major candidate in a probable run-off vote - with the exception of Haddad, with whom he was in a technical tie.

The potential for a leftist run-off victory spooked financial markets on Tuesday, with the real currency slumping nearly two percent against the US dollar and the Bovespa benchmark stock index losing 1.9 percent.

"Bottom line: one space in the run-off looks guaranteed for Bolsonaro," Juliano Ferreira, a strategist at brokerage BGC Liquidez, said in a research note.

"Once he's there, his chances of losing look stronger, to whomever it might be."

Lula's letter anointing Haddad will be read to supporters who have camped outside the police building for five months to protest his jailing, which they consider a plot to keep him from returning to power, a party official said.

Lula and Haddad huddled on Monday afternoon in his jail cell and began to draw up the letter, the source said.

The sources asked not to be named because they were not authorised to speak publicly about Lula's plans.

Lula served as president from 2003-2010. He is ineligible for office under Brazil's "Clean Slate" law, which prohibits candidates from running if they have convictions that have been upheld on appeal.

(Reporting by Lisandra Paraguassú in Curitiba; Additional reporting by Paula Arend Laier and Claudia Violante in Sao Paulo; Writing by Anthony Boadle; Editing by Brad Brooks and Dan Grebler)