Growth of snow gum seedlings (Eucalyptus pauciflora Sieb. ex Spreng.) was studied in response to differences in microclimate caused by differential heat exchange between seedlings, grass and bare, moist soil during winter and spring. Seedlings were planted in a pasture either directly into grassy groundcover or in circular patches of bare soil of 30, 60 or 120 cm in diameter. There were no differences in maximum air temperatures at seedling leaf height between treatments. However, minimum air temperature increased by 2 °C with increase in patch diameter from 0 to 120 cm such that seedlings surrounded by grass experienced lower minimum temperatures with more frequent and more severe frosts than seedlings growing in large patches of bare soil. These small-scale differences in minimum temperature affected both photosynthetic and growth processes. Over winter, seedlings were photoinhibited, with depression in midday Fv/Fm linearly related to minimum temperatures. In spring, repeated frosts and lower minimum temperatures led to a delay in the recovery of Fv/Fm, a delay in bud-break, damage to elongating stems and developing leaves, lower rates of stem elongation, and ultimately a shorter growing season for seedlings in grass compared to those in bare soil patches. Thus, microclimate above grass adversely affects spring growth of juvenile Eucalyptus pauciflora and may account for much of the competitive inhibition of tree seedling growth by grass during spring.