Sir Keir Starmer has accused officials in the Foreign Office of deliberately and repeatedly withholding the fact Lord Mandelson initially failed security vetting for the role of US ambassador.
Giving a statement to MPs, the prime minister said if he had known, he would not have gone ahead with the appointment.
Sir Keir found out last Tuesday the Foreign Office had gone against the recommendation of the security vetting agency and cleared Lord Mandelson for the job.
Conservative leader Kemi Badenoch has called for the PM to resign, saying he had "thrown his staff and officials under the bus" rather than "taking responsibility".
She accused Sir Keir of misleading the House of Commons when he previously told MPs "full due process" had been followed during the appointment and said he should have corrected the record last week "at the earliest opportunity".
The PM insisted he had not misled the Commons.
The Ministerial Code states that ministers who knowingly mislead Parliament are expected to resign, while any inadvertent error should be corrected "at the earliest opportunity".
The decision to appoint Lord Mandelson to the key diplomatic role has dogged Sir Keir for months and the PM's statement does not appear to have drawn a line under the issue.
Lord Mandelson was announced as the UK's ambassador to the US in December 2024, before in-depth vetting had been carried out.
He formally took up the role on 10 February 2025 but was sacked just seven months later over his ties to the late convicted sex offender Jeffrey Epstein.
UK Security Vetting, a specialist agency within the Cabinet Office, began the vetting process in late December 2024, and on 28 January 2025, recommended Developed Vetting clearance should be denied.
But Foreign Office officials went against this advice and granted him clearance.
In his statement, the PM said there had been repeated occasions when they should have told him this.
These included when Lord Mandelson was appointed and when he was sacked, as well as the point at which the PM subsequently ordered a review of the vetting process.
Sir Keir said the then-head of the Civil Service, Sir Chris Wormald, should also have been told when he was asked to review the appointment process last September, describing it as "astonishing" that he had not been.
He added that the information should have been shared with Foreign Secretary Yvette Cooper when she was responding to questions about the appointment from the Commons Foreign Affairs committee last September.
He said it was "absolutely unforgivable" Cooper had not been informed.
"A deliberate decision was taken to withhold that material from me," he told MPs.
"This was not a lack of asking. This wasn't an oversight. It was a decision taken not to share that information on repeated occasions."
The PM said it was "frankly staggering" he had not been told even when he launched a review of the vetting process.
While he accepted "sensitive, personal information" provided during the vetting process should be protected, he rejected the idea ministers could not be told the overall recommendation.
The most senior civil servant at the Foreign Office, Sir Olly Robbins, was effectively sacked on Thursday, after a Guardian investigation revealed his department had gone against the recommendation that Lord Mandelson should not be given security clearance.
Sir Keir did not name Sir Olly in his initial statement to MPs, instead referring to officials.
However, asked directly what Sir Olly had told him about why he had overruled the vetting recommendation, the PM said the civil servant's view had been that "he wasn't allowed to provide this information to me".
Allies of Sir Olly have argued he had a duty not to disclose details of the vetting, which are highly intrusive and personal, as this would undermine the process.
He is due to give evidence to the Commons Foreign Affairs Commitee on Tuesday morning.
Badenoch has been granted an emergency debate in Parliament later on.
Labour MP Dame Emily Thornberry, who chairs the committee, said that when it had previously asked the senior civil servant about the vetting process "we got a partial truth".
She questioned whether for certain members of the PM's team "getting Peter Mandelson the job was a priority that overrode everything else and that security considerations were very much second order".
Thornberry was one of a number of Labour MPs who made critical interventions in the Commons.
While last week some Labour MPs were reluctant to criticise the prime minister, one told the BBC his performance in the Commons had been "abysmal" and the mood among backbenchers was "very, very bad".
Chris Hinchliff, the Labour MP for North East Hertfordshire, said it seemed "wholly incredible" that the decision to overrule the vetting recommendation had been "made on a personal whim by a senior civil servant".
Instead he suggested there was "political pressure from Number 10 to advance a man who a particular faction in the Labour Party has looked to for moral and spiritual leadership for years".
Fellow Labour MP Neil Duncan-Jordan also questioned why Lord Mandelson was "ever considered for such an important role".
Sir Keir insisted there was no pressure from Downing Street to push through the appointment of the former Labour minister, whose links to Epstein were public knowledge at the time.
Earlier, it emerged that Sir Keir had appeared to have been advised to make Lord Mandelson go through security vetting before he was announced as ambassador.
An official document published last month showed Lord Case, the UK's top civil servant at the time, had written to Sir Keir a month before Lord Mandelson was appointed suggesting a political appointee should get security clearance before a candidate was confirmed as the PM's choice.
However, Sir Keir argued it was normal for security clearance to happen after appointment and before the individual took up the post, pointing to comments from Lord Case's successor Sir Chris to the Foreign Affairs Committee last year.
The PM added that he had changed the process after Lord Mandelson's sacking so an appointment could not be announced until after security vetting was passed.
The Foreign Office's power to make the final decision on security clearance was also suspended last week.
Lib Dem leader Sir Ed Davey said the PM should resign after a "catastrophic error of judgement" in appointing Lord Mandelson.
Reform UK and the Green Party have also called for Sir Keir to go, accusing him of lying about Lord Mandelson's vetting.
Plaid Cymru said the PM should stand down for misleading the public, while the SNP suggested Sir Keir was either "gullible, incompetent or both".
US President Donald Trump called Lord Mandelson a "really bad pick" on Truth Social, writing that Sir Keir had "acknowledged that he 'exercised wrong judgement' when selecting the US ambassador role".
"I agree, he was a really bad pick. Plenty of time to recover, however!" Trump said in his post.
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