OK...my little one is six months old and we had the same problem almost as severe as you that started at month 2. Her's was so bad that she started loosing pigment on her face. I was terrified she'd be scarred for life. I promise you it will go away --although its a slow process and we are still dealing with it. Here are my suggestions.
a) Change all her baby lotions and cleansers to Cetaphil immediately. Its expensive but worth it you can find large bottles of the cleanser and lotion at Costco. If you live in the area the one in Richmond carries them. Otherwise go to Target --smaller bottles though.
b) Change her laundry soap to liquid ALL CLEAR. Not as nice smelling as Dreft but again you won't have to worry if its something in Dreft. ALL is safe for baby clothes. And use unscented BOUNCE.
c) On the subject of Benadryl, we give our baby Children's Claritin 1x per day and Children's Benadryl 1x at night. Claritin can not be given more than once a day. Ask the Pharmisist the right dosage for your baby's weight and age. This helps with the itching. Our Dr. told us that babies don't understand where they itch so they will pick the place closest to them and scratch away. Its usually their heads. Our baby was pulling out her hair she was so miserable. Once we started giving her medicine it kept the flare ups calm so not as much scratching. We started it last month and did it for 3 weeks straight --the episode was bad. We have since tapered off and I gave it to her two days last week when the weather shifted and she started to flare-up. Once the flare-up calmed down we stopped giving it to her. We don't want her to be dependant on it.
d) Don't bathe the baby everyday, especially during a flare-up. We learned the hard way. The water dries out their skin more. And washing her hair irritated her scalp with all the rubbing. So we bathe her every 2-3 days and she gets a "sponge bath" on non bath days. As she gets older you can adjust this schedule as you see fit.
e) About the scalp. We rubbed olive oil on her scalp every night and morning. Its a natural and it helps keep the scalp moist. Don't try to lift the cradle cap when her scalp is dry. And don't use the over the counter products perfumes and dyes are irritating. I used those and her scalp became more irritated so much so that when I washed her hair she screamed the minute I touched her. You MUST keep the cradle cap off the scalp as much as possible it will spread and cause her hair to fall out. So use olive oil, massage it in (they love that) and lift gently with a fine tooth comb, then rinse with warm water. After you rinse put more olive oil in and let her be till the next round. Don't be obsessive (I was and it makes it worse for them)get as much as you can and try again the next day. Give a regular shampoo on bath days. Always use the olive oil.
d) About her face. At least 4-6 times a day alternate hydrocortisone and auqaphor. This will help soothe her skin. Keep her nails super short and put those baby mitts on her at night. Ours just stopped using them. I don't think you need to use hydrocortisone all over her body just on the "hot spots". Use the Cetaphil lotion on the rest of her body. Do not wipe her face with dry napkins, towel or wipes. Gently use a wet wash cloth and pat her face --no rubbing.
e) Keep her out of direct sunlight. In the beginning my child didn't go anywhere with out a hat. I would let her sit in the carseat without it and then I would drap something to ensure not sun hit her face. www.gottahavahat.com has great baby wide brim hats made of special UV material. Well worth the money. You don't want her to tan during a breakout --scarring may be irriversible depending on her level of skin sensitivity. And yes, people will talk about you --so what. My family still makes fun of me. Its all about the baby.
f) AVOID polyester and fleece as much as possible. If you own something like that make sure she has a cotton onsie underneath so it doesn't touch her skin. They tend to sweat in that material and sweat makes the flare-ups worse.
g) When you see her start trying to scratch use your hands and rub the area for her --like a massage. It redirects her attention and she'll like it. Use this technique when she starts burrowing her face into your clothes or sheets. This behaviour likely means she is itching. Try wet cool towels on her face to help cool the skin and take the itch out.
h) What the cycle of her flare-ups. They will likely get worse when the weather goes from cool to warm, rain to sun or vice versa. Being aware will help you know when to put things into place for her to help the flare-up and her coping skills.
i) Keep your house on the cooler side. Heat and dry air make the problem worse. Even it means running the heat to keep others warm and having a window open.
Our baby has gotten better as she gets older. We are still dealing with it on some level. We use all of the techinques I have suggested and they work. Good luck. Let me know if you have any other questions.