The Prime Minister is under fire for using the word "gay" to describe a red top, worn by The Farming Show presenter Jamie Mackay in an interview, on the same day Mr Key reportedly called footballer David Beckham "thick as batsh*t".
"You're munted mate. You're never going to make it. You've got that gay red top on," he told Mackay.
Sir Ian, who plays Gandalf in the Lord of the Rings series and upcoming The Hobbit trilogy, said Key's language reflected badly on New Zealand.
In a blog posted today, the openly gay actor said New Zealand had a proud history of leading the world on social issues.
"Mr Key should watch his language," he said.
"I'm currently touring secondary schools in UK, attacking homophobia in the playground and discouraging kids from the careless use of 'gay' which might make their gay friends (and teachers) feel less about themselves.
"So even as he supports the proposal to introduce same-gender marriages in New Zealand, I do hope John Key listens to his critics and appreciates their concern. Careless talk damages lives," he said.
Key yesterday said he meant "weird" when he used the word "gay" in the interview.
He had picked up the term from his children and had no intention of sounding homophobic.
Though he agreed it was an unfortunate use of words, he said: "a hell of a lot of people would use it, and the common use of it is in the Oxford dictionary".
Sir Ian said many words that can offend people are in the dictionary.
He said New Zealand should value its history of leading the world on many social and policy issues.
Key also courted controversy over reports he branded David Beckham "thick as batsh*t" while speaking to a group of students at Dunedin's St Hilda's Collegiate last Friday.
He has refused to confirm or deny insulting the football superstar.
However, British media have picked up the story.
Beckham's London-based media guru Simon Oliveira - who also oversees global campaigns for tennis ace Andy Murray and Formula One star Lewis Hamilton - was not impressed.
"It is not worthy of comment."
- Hayden Donnell and APNZ