The induction of developmental structures derived from the ectoderm, such as the neural tube or tooth, occurs through neutralization of the inhibitory activity of members of the bone-morphogenetic protein (BMP) family by BMP antagonists. Here we show that, during hair-follicle development, the neural inducer and BMP-neutralizing protein Noggin is expressed in the follicular mesenchyme, that noggin-knockout mice show significant retardation of hair-follicle induction, and that Noggin neutralizes the inhibitory action of BMP-4 and stimulates hair-follicle induction in embryonic skin organ culture. As a crucial mesenchymal signal that stimulates hair-follicle induction, Noggin operates through antagonistic interactions with BMP-4, which result in upregulation of the transcription factor Lef-1 and the cell-adhesion molecule NCAM, as well as through BMP4-independent downregulation of the 75 kD neurotrophin receptor in the developing hair follicle.