This study examines the mechanism by which TGF-β1, an important mediator of cell growth and differentiation, blocks the differentiation of normal rat diploid fetal osteoblasts in vitro. We have established that the inability for pre-osteoblasts to differentiate is associated with changes in the expression of cell growth, matrix forming, and bone related genes. These include histone, jun B, c-fos, collagen, fibronectin, osteocalcin, alkaline phosphatase, and osteopontin. Morphologically, the TGF-β1-treated osteoblasts exhibit an elongated, spread shape as opposed to the characteristic cuboidal appearance during the early stages of growth. This is followed by a decrease in the number of bone nodules formed and the amount of calcium deposition. These effects on differentiation can occur without dramatic changes in cell growth if TGF-β1 is given for a short time early in the proliferative phase. However, continuous exposure to TGF-β1 leads to a bifunctional growth response from a negative effect during the proliferative phase to a positive growth effect during the later matrix maturation and mineralization phases of the osteoblast developmental sequence. Extracellular matrix genes, fibronectin, osteopontin and α1(I) collagen, are altered in their expression pattern which may provide an aberrant matrix environment for mineralization and osteoblast maturation and potentiate the TGF-β1 response throughout the course of osteoblast differentiation. The initiation of a TGF-β1 effect on cell growth and differentiation is restricted to the proliferative phase of the culture before the cells express the mature osteoblastic phenotype. Second passage cells that are accelerated to differentiate by the addition of dexamethasone or by seeding cultures at a high density are refractory to TGF-β1. These in vitro results indicate that TGF-β1 exerts irreversible effects at a specific stage of osteoblast phenotype development resulting in a potent inhibition of osteoblast differentiation at concentrations from 0.1 ng/ml. © 1994 Wiley-Liss, Inc.