TOWIE's Danielle spoke about the surprise encounter between the exes, which happened in Marbella, while filming for Celebrity Juice and she said she believed Lydia saw it as a "mistake".
Hinting that things got frisky after Arg had begun talking to another woman, Danielle said: "I think he might have been talking to someone else and there was a little bit of…I don't know. Anyway, they ended up sleeping together."
Celebrity Juice panelist Holly Willoughby described Lydia's behaviour as "naughty", saying: "That's a bit naughty though, he really loves her." Danielle replied: "He really loves her and it's really sad. I love Arg. It's really hard when you're altogether on holiday, there's drink involved, your exes are there…"
She added: "I was honestly really shocked, I couldn't believe it because I thought it was kind of finished."
Whispers that Lydia and Arg had slept together while filming the opening episode for the new series of TOWIE emerged earlier this week.
On Thursday (6 October), Arg confirmed hooking up with his ex girlfriend, saying: "My head has gone."
Speaking to co-star Tommy Mallet for TOWIE's social media sites, he continued: "It's been emotional. As per usual, people's heads have gone. My head has gone... it went after I stayed the night with the love of my life. My head went. I didn't know whether I was coming or going."
It has also been reported that Lydia "deeply regrets" sleeping with Arg. A source told The Sun: "Lydia can't believe she fell for Arg's charms once again. She puts it down to having a weak moment and deeply regrets leading him on."
During her appearance on Celebrity Juice, which will airs tonight (Thursday), Danielle was asked by Keith Lemon whether the dalliance means Lydia and Arg are back together. She replied: "No, apparently it was a mistake on Lydia's behalf."
Celebrity Juice airs at 10pm, ITV2 on Thursday 6 October. TOWIE returns to ITVBe at 10pm on Sunday 9 October. Watch Danielle on Celebrity Juice here: