Transforming growth factor beta (TGF-beta) is one of the most abundant of the known growth regulatory factors stored within the bone matrix. When bone is resorbed, TGF-beta is released in an active form and is a powerful bone growth stimulant. When injected into the subcutaneous tissue over the calvarial surface of rodents, it rapidly causes proliferation of the periosteal layer and accumulation of new woven bone. In this report, we describe the effects of TGF-beta 1 on first subcultures of fetal rat osteoblasts obtained from calvarial bones and cultured from confluence with ascorbic acid and beta-glycerophosphate. Under these conditions, nodules with characteristics of normal bone appear by day 8. Similar to experiments described by Antosz et al., TGF-beta added to confluent cultures inhibited the formation of bone nodules. Both the number and total area of the nodules were quantitated and shown to be completely inhibited by 2 ng/ml of TGF-beta 1. TGF-beta also impaired the expression of genes associated with bone formation, including type I collagen, alkaline phosphatase, osteopontin, and osteocalcin. TGF-beta also inhibited the expression of mRNA for the bone morphogenetic protein 2 (BMP-2). These results, showing suppression of markers representative of osteoblast differentiation, suggest that the effects of TGF-beta to stimulate bone formation in vivo are not likely a result of effects on differentiated mineralizing osteoblasts but, as suggested by previous studies, more likely are caused by effects on osteoblast precursors. These results also suggest that endogenous BMP-2 expression in fetal rat calvaria cells is important for bone cell differentiation.