Mr Yaalon was military chief of staff at the time of the Shehadeh attack
Israeli minister and former military chief Moshe Yaalon cancelled a UK visit because of fears of arrest for alleged war crimes, his office says.
Pro-Palestinian groups in Britain want Mr Yaalon to face trial over the 2002 killing of a Gaza militant, in which 14 others also died.
Mr Yaalon took legal advice and wanted "to avoid playing into the hands of anti-Israel propaganda", an aide said.
A similar attempt last week failed to get Israel's defence minister arrested.
Mr Yaalon, who is vice prime minister and strategic affairs minister, had been invited to attend a charity dinner held by the Jewish National Fund's UK branch.
But his spokesman, Alon Ofek-Arnon, confirmed that the foreign ministry's legal team had advised against it.
Israeli media reported that the advisers believed Mr Yaalon would not be accorded diplomatic immunity - in contrast to Defence Minister Ehud Barak who visited the Labour Party Conference in Brighton without interference.
"This is a campaign whose goal is to de-legitimise the state," Mr Yaalon said in remarks quoted by Haaretz newspaper.
Allegations against Mr Yaalon date back to July 2002, when an Israel Air force jet dropped a one-tonne bomb in a densely populated area of Gaza to assassinate senior Hamas figure Salah Shehada.
The attack was part of Israel's policy of "targeted killings" of Palestinian militants it blamed for plotting attacks against it.
At the time, the army expressed regret about the deaths of the 14 civilians, at least eight of them children, killed in addition to Mr Shehada and said they had come about as the result of faulty intelligence.
Britain has adopted the legal principle of "universal jurisdiction", under which domestic courts in countries around the world can try war crimes suspects, even if the crime took place outside the country and the suspect is not a citizen.
Palestinian campaigners sought Mr Barak's arrest last week, in connection with Israel's controversial military operation in Gaza in December 2008 and January 2009, but judges declined to hear the case.
A UN report by international prosecutor Richard Goldstone accused both Israel and Hamas of war crimes. Israel rejected its findings.