After cellularization of the Drosophila embryo, positional differences within each primordial segment are maintained and elaborated by processes that require cell interactions. The best-documented examples of such intercellular signalling are the mutual interactions between neighbouring cells expressing the homeodomain protein engrailed and the secreted glycoprotein encoded by wingless, the Drosophila homologue of the murine Wnt-1 gene. Little is known about the molecular basis of these signalling mechanisms but the activities of several other genes, notably patched and hedgehog, have been implicated in the process. Here we show that the role of patched in positional signalling is permissive rather than instructive, its activity being required to suppress wingless transcription in cells predisposed to express the latter. According to this view, expression of wingless is normally maintained only in those cells receiving an extrinsic signal, encoded by hedgehog, that antagonizes the repressive activity of patched. We suggest that the patched protein may itself be the receptor for this signal, implying that this is an unusual mechanism of ligand-dependent receptor inactivation.