PPM1D (PP2Cδ or Wip1) was identified as a wild-type p53-induced Ser/Thr phosphatase that accumulates after DNA damage and classified into the PP2C family. It dephosphorylates and inactivates several proteins critical for cellular stress responses, including p38 MAPK, p53, and ATM. Furthermore, PPM1D is amplified and/or overexpressed in a number of human cancers. Thus, inhibition of its activity could constitute an important new strategy for therapeutic intervention to halt the progression of several different cancers. Previously, we reported the development of a cyclic thioether peptide with low micromolar inhibitory activity toward PPM1D. Here, we describe important improvements in the inhibitory activity of this class of cyclic peptides and also present a binding model based upon the results. We found that specific interaction of an aromatic ring at the X1 position and negative charge at the X5 and X6 positions significantly increased the inhibitory activity of the cyclic peptide, with the optimized molecule having a K(i) of 110 nM. To the best of our knowledge, this represents the highest inhibitory activity reported for an inhibitor of PPM1D. We further developed an inhibitor selective for PPM1D over PPM1A with a K(i) of 2.9 μM. Optimization of the cyclic peptide and mutagenesis experiments suggest that a highly basic loop unique to PPM1D is related to substrate specificity. We propose a new model for the catalytic site of PPM1D and inhibition by the cyclic peptides that will be useful both for the subsequent design of PPM1D inhibitors and for identification of new substrates.