LIM-homeobox containing (Lhx) genes encode trascriptional regulators which play critical roles in a variety of developmental processes. We have identified two genes belonging to a novel subfamily of mammalian Lhx genes, designated Lhx6 and Lhx7. Whole-mount in situ hybridisation showed that Lhx6 and Lhx7 were expressed during mouse embryogenesis in overlapping domains of the first branchial arch and the basal forebrain. More specifically, expression of Lhx6 and Lhx7 was detected prior to initiation of tooth formation in the presumptive oral and odontogenic mesenchyme of the maxillary and mandibular processes. During tooth formation, expression was restricted to the mesenchyme of individual teeth. Using explant cultures, we have shown that expression of Lhx6 and Lhx7 in mandibular mesenchyme was under the control of signals derived from the overlying epithelium; such signals were absent from the epithelium of the non-odontogenic second branchial arch. Furthermore, expression studies and bead implantation experiments in vitro have provided strong evidence that Fgf8 is primarily responsible for the restricted expression of Lhx6 and Lhx7 in the oral aspect of the maxillary and mandibular processes. In the telencephalon, expression of both genes was predominantly localised in the developing medial ganglionic eminences, flanking a Fgf8-positive midline region. We suggest that Fgf8 and Lhx6 and Lhx7 are key components of signalling cascades which determine morphogenesis and differentiation in the first branchial arch and the basal forebrain.