The Royal British Legion has cut ties with the News of the World as its campaigning partner amid claims the paper may have hacked into the mobile phones of bereaved military families.
Chief of the Defence Staff Gen Sir David Richards said the claims were "disgusting" and he was "appalled".
The paper's owner, News International, said it would be "horrified" if the reports turned out to be true.
According to the Daily Telegraph, the phone numbers of relatives of service personnel killed in Iraq and Afghanistan were found in the files of private investigator Glenn Mulcaire, who had been working for the News of the World.
Police have not approached relatives of the soldiers but some families say a newspaper has contacted them suggesting they were victims of phone hacking.
The Royal British Legion also said it was reviewing its advertising with News International, which publishes the Sun and The Times, as well as the NoW, the UK's top-selling newspaper.
Meanwhile, the Independent Police Complaints Commission has been asked to supervise the Met Police's internal investigation into payments by journalists to police for information.
Met Commissioner Sir Paul Stephenson said a small number of officers were alleged to have taken illegal payments. "If true, I will be determined to root them out, find them and put them in front of the criminal court," he said.
In other developments:
Prime Minister David Cameron is consulting MPs about the nature of a public inquiry into the phone-hacking claims, amid support by the deputy prime minister and the Labour leader for a judge-led hearing, with powers to call evidence and examine witnesses under oath
Shares in BSkyB fall on fears that the News of the World phone-hacking scandal could hinder parent company News Corp's bid for the broadcaster
Culture Secretary Jeremy Hunt is set to delay his decision on whether to allow News Corp's bid for BSkyB after receiving 100,000 submissions on the issue
Michael Mansfield QC, who represented Mohamed Al Fayed at the Princess Diana inquest, has been told his phone may have been hacked
The Crown Office say Strathclyde Police have been asked to look at evidence given by witnesses during the Tommy Sheridan perjury trial, in light of recent allegations
Sainsbury's supermarket, O2, Flybe, Specsavers and Dixons follow the example of other companies including Ford and Npower by suspending advertising in the NoW
The government is to urgently review its advertising contracts with the News of the World
Peter Ridsdale, chairman of Plymouth Argyle, tells BBC Radio Devon, his e-mails were hacked into and he is seeking damages from the News of the World following an article published by the paper when he was chairman of Cardiff City
The Royal British Legion campaigned with the News of the World on Military Covenant issues and was set to mount another initiative with the paper to save the chief coroner's office from abolition.
The charity's adverts have also appeared in the Sun and on the Sun's Forces Channel online to promote its welfare services for serving and former military personnel and their relatives.
A spokesman for the charity said: "We can't with any conscience campaign alongside News of the World on behalf of armed forces families while it stands accused of preying on these same families in the lowest depths of their misery.
"The hacking allegations have shocked us to the core."
He added: "Clearly, it would make a mockery of that campaign to go hand-in-hand with News of the World. We think we'll do better without them."
Outrageous breach
News International is co-operating with a police inquiry into hacking at the News of the World and is conducting its own investigation into the claims.
"If these allegations are true we are absolutely appalled and horrified," the company said in a statement, adding that its "record as a friend of the armed services and of our servicemen and servicewomen, is impeccable".
The latest developments come after reports claimed the paper hacked into the mobile phone of murdered schoolgirl Milly Dowler, the families of 7/7 bombing victims and the parents of murdered Soham schoolgirls Holly Wells and Jessica Chapman.
Defence Secretary Liam Fox said: "If these claims prove to be true then the intrusion into the private lives of bereaved families would be an outrageous breach of trust and I would strongly condemn anyone involved.
"Our armed forces and their families rightly deserve the respect and support of the nation particularly when their loved ones have made the ultimate sacrifice."
Gen Sir David Richards said he did not wish to pre-empt the results of the ongoing police investigation into hacking, but said he found the allegations "quite disgusting" and would be appalled if they proved true.
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