"The costs involved in the settlement with Mr Ambrose will not be met by the taxpayer," a spokeswoman said.
The legal costs which Mr Key had incurred so far in the case had already come out of his leader's budget.
His office said Mr Key was given approval by the Speaker in 2013 to use the fund for this purpose. It was not known how much he spent on his legal defence.
Leader of the Opposition Andrew Little and New Zealand First leader Winston Peters criticised Mr Key yesterday for using public money to cover the settlement.
Speaker David Carter's office confirmed this afternoon that MPs could not use a leaders' fund for a legal settlement.
MPs could apply to use the fund for legal advice and representation, but not for damages, a spokesman said.
At a press conference in Lower Hutt this afternoon, Mr Key denied that he had bowed to public pressure.
He would have persisted with using his leader's fund to pay the settlement if it was within the rules, he said.
"Where the rules apply we will be using them and we have done that since [the start of the defamation case] in 2013.
He was unaware that he was not allowed to use the leader's budget for a court settlement until he was advised by Parliamentary Service today.
Mr Key said he was acting as leader of the National Party at the time that he made the comments about Mr Ambrose so it was appropriate that the party covered the cost of the settlement.
He said legal challenges were one of the realities of being an MP. Like journalists, MPs' employers often covered their legal fees.
"If that entity is TVNZ or Maori TV, then it's taxpayer's money. It's no different. Most employers indemnify their employees if they're acting as an employee."
Mr Key also took aim at Labour, saying former Prime Minister Helen Clark had used public money to settle a defamation case.
In 2001, the Crown paid a $55,000 settlement to a man convicted of manslaughter after Clark wrongly called him a murderer.
A spokeswoman for Labour leader Andrew Little said he had never used public money for legal costs.
When he and fellow Labour MP Trevor Mallard were sued for defamation in 2012 by then-ACC Minister Judith Collins, the Labour Party paid their bills.
Mr Ambrose took a defamation claim against Mr Key after the Prime Minister claimed he had made an illegal recording of a meeting with former Act leader John Banks in a Newmarket cafe during the election campaign in 2011.
The cameraman, who was working for the Herald on Sunday at the time, said that the recording was not deliberate and that he had struggled to find work since as a result of Mr Key's criticism.
