The editor-in-chief of Associated Newspapers today refused to withdraw an allegation that Hugh Grant made "mendacious smears", unless the actor withdrew his own suggestions that the group had been involved in phone hacking.
Paul Dacre told the Leveson Inquiry that Grant was "obsessed with trying to drag the Daily Mail into another newspaper's scandal".
He said he had had to issue the statement in November in order to "fight fire with fire".
The editor of the Daily Mail was recalled to the inquiry to answer questions about Grant's claims that a story about his relationship with socialite Jemima Khan was likely to have come from illicit eavesdropping.
The story, published in the Mail on Sunday in February 2007, claimed Grant's relationship with Khan was being affected by telephone conversations he was having with a "plummy-voiced executive".
At the inquiry on Thursday Dacre repeated insistences that phone hacking had not taken place at Associated Newspapers, saying the group had already admitted the story was wrong and had paid modest damages to the actor.
David Sherborne, who is representing victims of phone hacking at the inquiry, said there were no fewer than eight references in the story to phones or phoning, and three or four references to the woman having a "plummy voice".
But Dacre told him: "This is three or four paragraphs in a 2,000 word piece."
He said they had admitted that part of the story was wrong, and had paid damages to Grant.
Dacre said at the time Grant had insisted he knew no such woman and no woman existed of that kind.
But the inquiry heard evidence was later produced that the woman with the "plummy voice" was Tricia Owen, an executive assistant to the president/CEO of Castle Rock Entertainment.
Dacre said: "Let's go back to the first day of the inquiry, it was an extraordinary occasion, there's never been an inquiry like this before, it was being televised, beamed around the world, it was a unique occasion.
"Grant, a poster boy for the Hacked Off campaign, is giving evidence on the first day, an international film star. He makes his allegation, it was not an innocent piece of evidence, it had been drawn out of him by the inquiry.
"He makes it. He had not included it in his witness statement. He knew, I would suggest, the damage it would cause. After all, allegations of phone hacking has closed down a newspaper that has resulted in the loss of work by hundreds and hundreds of journalists.
"It was explosive and it was toxic."
Dacre, the longest-serving Fleet Street editor, said Grant had made several suggestions previously that the newspaper was involved in hacking.
He told the inquiry he had to issue the statement accusing Grant of "mendacious smears" as a strong rebuttal of the suggestion.
Dacre added that his inquiries had found there was no phone hacking at Associated Newspapers.
He said: "All my inquiries, all the evidence that I have received and having spoken to the editors of my group, our group did not hack phones and I rather resent your continued insinuations that we did.
"I am satisfied that legitimate journalistic methods were used to obtain the source for the basis of these three paragraphs."
Earlier at the inquiry Heather Mills said that a message left on her phone by former husband Sir Paul McCartney appeared to have been listened to by journalists.
Mills said she was called by a Trinity Mirror employee who confronted her with the information from the messages. Counsel to the inquiry, Robert Jay QC, clarified that the person was not former Daily Mirror and News of the World editor Piers Morgan or anyone employed by him
Mills said she told the employee: "I promise you if you report this story, even though it's true, you've obtained this information illegally and I will do something about it."
The news story was not published, but the incident is now the subject of a police investigation into phone hacking.
Former News of the World news editor Ian Edmondson also gave evidence to the inquiry, in which he described the "culture of bullying" created at the newspaper by former editor Colin Myler.