News Corp has withdrawn its £8.7bn bid for BSkyB, it was announced on Wednesday.
The shock withdrawal of the bid represents a massive defeat for Murdoch, who just one week ago looked certain to complete his takeover of the broadcaster.
Public anger over allegations involving News International journalists hacking into the phones of murdered schoolgirl Milly Dowler and the families of dead servicemen and women, and further claims that reporters paid corrupt police officers for information, was increasingly focused on the BSkyB bid after Murdoch decided to close the embattled News of the World tabloid.
In a statement Chase Carey, Deputy Chairman, President and Chief Operating Officer of News Corporation, said:
"We believed that the proposed acquisition of BSkyB by News Corporation would benefit both companies but it has become clear that it is too difficult to progress in this climate. News Corporation remains a committed long-term shareholder in BSkyB. We are proud of the success it has achieved and our contribution to it."
Number 10 said they welcomed the news: "As the prime minister has said, the business should focus on clearing up the mess and getting its own house in order."
Ed Miliband, the Labour leader, said the public had made its voice heard on the decision: "This is a victory for people up and down this country who have been appalled by the revelations of the phone hacking scandal and the failure of News International to take responsibility."
"People thought it was beyond belief that Mr Murdoch could continue with his takeover after these revelations ... They told Mr Murdoch: 'This far and no further'."
Deputy Prime Minister and LibDem leader said in a tweet: "This is the decent and sensible thing to do."
The bid was referred to the Competition Commission on Monday after News Corp withdrew a previous offer to spin off Sky News.
The Commons debate scheduled for Wednesday afternoon in which all three major parties were set to call on Murdoch to withdraw the bid is still expected to go ahead.
MP Ivan Lewis, who is Labour's spokesman on culture, said: "What we mustn't allow this announcement to be today is the end of the need to get to the bottom of this unethical and criminal behaviour that has so damaged the newspaper industry, but has also threatened to undermine our democracy."
Lewis said he hoped the debate would still go ahead: "Obviously that's a matter that will be being discussed - there are conversations taking place. It's likely, I think, that the debate will go ahead, but that's something that will have to be considered over the next hour or so."
David Babbs, executive director of the online activism group 38 Degrees who along with Avaaz and others have campaigned strongly for an end to the BSkyB deal over the last few days, told The Huffington Post that it was a victory for democracy.
He said: "This is a result for hundreds of thousands of people who have spoken out over the last few days ... Nearly 100,000 38 Degrees members have emailed their MPs in the last few days to express their feelings on the deal."
Babbs added that 38 Degrees had "made it clear to MPs that they couldn't hide behind legal technicalities" and that he hoped the collapse of the takeover marked a turning point for the relationship between politics and media in the UK.
"I hope Rupert Murdoch finally starts respecting British democracy," Babbs said.