David Cameron admitted today that the decision to employ former News of the World editor Andy Coulson had "haunted" him.
The Prime Minister told the inquiry he knew making Coulson his director of communications was a "controversial appointment".
But he insisted that he had sought assurances from the former editor that he had no knowledge of phone-hacking practices at the now-defunct newspaper.
Cameron said: "Why did I feel he deserved a second chance? Because I though that he had done the honourable thing. Something very bad had happened on the newspaper he was editing. He did not know and he resigned."
Coulson had also given the same assurances to the police, Press Complaints Commission and the Culture, Media and Sport Select Committee at various stages, which had all "accepted his word", Cameron added.
He said: "I just make one point, because I recognise this is a controversial appointment. This has come back to haunt both him and me, but in doing the job of director of communication for the party and in Downing Street he did the job very effectively."
Cameron told the inquiry he believed he sought assurances from Coulson over phone hacking during a face-to-face meeting in his parliamentary office in March 2007.
"I knew it was very important that I needed to ask him that question, therefore did so."
Coulson suggested in evidence that he was asked about the matter in a phone call at a later date.
Cameron said: "The key thing is, I asked for assurances. I got them and on that basis I employed him."
In a written statement to the inquiry, he added: "He denied any knowledge of the hacking but said he took responsibility for what had happened on his watch.
"I asked him specifically about his involvement.
"My question was always whether any new evidence had been disclosed to suggest any knowledge of hacking.
"If such evidence had been revealed, I would not have employed him."
The inquiry was told Coulson had come up with the "most destructive" headline anyone ever had about him.
"Three words, hug a hoodie," he added, in reference to coverage of a speech he gave calling for more understanding about why young people became involved in crime.
Tim Shipman (Mail)
The Media Blog
Coulson resigned as editor of the News of the World in January 2007 after the paper's former royal editor Clive Goodman and private investigator Glenn Mulcaire were jailed for phone hacking.
In May 2007, Coulson was unveiled as the Conservative Party's director of communications and planning - three years before Cameron became Prime Minister in May 2010.
In January last year he resigned as Downing Street communications chief after admitting that the News of the World phone-hacking row had been making his job impossible.
Cameron said he had been looking for a "big hitter" who could cope with the intense pressure of the job of handling media strategy for a major political party.
The inquiry was told that over a weekend that could involve anything from policy issues, a scandal around an MP's expenses or a marriage breakdown.
"It literally comes down on top of your head. It's very fast and furious and you need someone seriously good at handling that."
The Prime Minister said he had talked to four other potential candidates about the position. One was Guto Harri, a former BBC employee who helped Boris Johnson in his mayoral election campaigning.
He refused to name the others but said the list included "someone senior from a broadsheet" as well another senior BBC employee and a tabloid journalist.
Cameron agreed that Liberal Democrat leader Nick Clegg had concerns about Coulson's role after the coalition Government was formed in 2010.
"I don't remember them being particularly strong," said Cameron. "As far as I recall it was 'There's been controversy about this. Are we sure he's the right man for the job?' I don't remember the conversation in any great detail."
Cameron added: "It may have been no more than wanting to ensure that people were, as it were, coalition-friendly."
He told the inquiry: "This was a controversial appointment... Clearly some people did have concerns."