At his regular post-Cabinet press conference, Mr Key was repeatedly asked whether it was correct to use taxpayer money to settle the defamation action.
If the Speaker rules the fund should not be used, the National Party would pay, Mr Key said.
"The rules have been pretty clear for a long period of time, and plenty of politicians have used the leaders' fund, or if it as a minister or prime minister, Crown Law. So there is nothing new here."
In 2001, the Crown paid a $55,000 settlement to a man convicted of manslaughter after Helen Clark wrongly called him a murderer.
National's Nick Smith accessed an undisclosed sum to defend a defamation action by a timber preservative company in 2010. Trevor Mallard had legal costs covered when he was a minister in 2001, but paid his own costs when Opposition MP in 1997 defending a defamation suit by then NZ First MP Tukoroirangi Morgan.
The settlement with Mr Ambrose came after Mr Key earlier referred the matter to police, leading to searches of the offices of the Herald and other media organisations.
Mr Key previously told his biographer John Roughan that the tea pot saga was one of the few times that something had truly "wound me up", that it had "hit me ... deeply".
Asked today about his change of position, he said the decision to settle was a pragmatic one.
"It became pretty clear it was highly unlikely there would be a recovery of any costs, and the cost of going to court was considerably more."
He could not recall who initiated the settlement meeting: "I can't remember the exact order of events, whether the judge thought it was a good idea rather than for it to go to court."
Mr Ambrose claimed the Prime Minister made defamatory comments about him after he recorded a private conversation between Mr Key and former Act Party leader John Banks at an Auckland cafe in the lead-up to the 2011 general election.
Mr Ambrose maintained the microphone was left on by mistake, and objected to Mr Key's public statements asserting that was not the case, and likening the conduct to that of the British tabloid News of the World.
A defamation trial had been set down for a two-week hearing next month, and a Givealittle fundraising campaign launched to help Mr Ambrose meet his legal costs.
Mr Ambrose told the Herald he could not comment on the settlement. On Instagram, he posted a picture of a cup of tea, with the caption: "I haven't enjoyed tea for breakfast for a long time. Tastes better today."
Labour leader Andrew Little said Mr Key's settlement was a "costly embarrassment", and he should apologise to both Mr Ambrose and the taxpayer.
NZ First leader Winston Peters said taxpayer money should not be used for "loose lipped" comments.
The tale of the teapot
November 11, 2011: Prime Minister John Key meets Act's John Banks at a Newmarket cafe for a symbolic cup of tea to induce National supporters to vote for the Act candidate. Their conversation is captured after freelance cameraman Bradley Ambrose leaves a recording device in a black bag on their table.
November 14: Mr Key lays a complaint with police after details of his conversation with Mr Banks are published in the Herald on Sunday.
November 23: Police search the offices of the Herald on Sunday and TVNZ as part of their investigation.
January 26, 2012: The recording is anonymously published online.
March 26: Police say that after a four-month investigation they chose not to press charges against Mr Ambrose.
May 5: Mr Ambrose reveals he and his lawyers are considering suing Mr Key for his comments about him.
December 9, 2014: Court documents reveal Mr Ambrose is suing Mr Key for $1.25 million.
Today: Mr Key and Mr Ambrose issue an agreed statement, which states Mr Key now accepts the recording was not deliberately made. The defamation proceeding has been settled.
