"Clearly I've misread the situation," Mr Key told Radio New Zealand. "I can absolutely assure people it was really meant in good humour and nothing else.
"But every person on the planet would accept that I should have read that situation better. And I clearly didn't and I regret that and I've apologised sincerely for it."
He said he did not believe it was sexist behaviour and he "could've" done it to a man.
"There is a bit of context there. And the context was a very good natured environment that we were in and it was very much a sort of thing in jest. So yes, technically it would have been possible."
Mr Key said his job often led to him being in hugged and touched by people in public.
"I think [Herald reporter] Claire Trevett wrote in one of her articles that it's a fairly tactile world that we live in.
"People come up to me all the time. I don't know how many thousands of selfies I do in a week or a month. People put their arms around me lots, kids come up to me, that sort of thing.
"But if you're asking me if it's an issue then I don't believe it is, no."
Mr Key said he had consulted lawyers in case he was required to answer questions in court on the issue.
Serial litigant Graham McCready is preparing a private prosecution, claiming that Mr Key committed assault.
Ms Bailey, 26, is also considering legal action and is getting advice from Unite Union.
Mr Key said his legal advice was "just a natural part of the process I need to observe".
He added: "On the basis that the District Court or others ask questions I obviously need to be in a position to respond to that."