Respiration produces rhythmic activity in the entire olfactory system, driving neurons in the olfactory epithelium, olfactory bulb (OB), and cortex. The rhythmic nature of this activity is believed to be a critical component of sensory processing. OB projection neurons, mitral and tufted cells exhibit both spiking and subthreshold membrane potential oscillations rhythmically coupled to respiration. However, the network and synaptic mechanisms that produce respiration-coupled activity, and the effects of respiration on lateral inhibition, a major component of sensory processing in OB circuits, are not known. Is respiration-coupled activity in mitral and tufted cells produced by sensory synaptic inputs from nasal airflow alone, cortico-bulbar feedback, or intrinsic membrane properties of the projection neurons? Does respiration facilitate or modulate the activity of inhibitory lateral circuits in the OB? Here, in vivo intracellular recordings from identified mitral and tufted cells in anesthetized rats demonstrate that nasal airflow provides excitatory synaptic inputs to both cell types and drives respiration-coupled spiking. Lateral inhibition, inhibitory postsynaptic potentials evoked by intrabulbar microstimulation, was modulated by respiration. In individual mitral and tufted cells, inhibition was larger at specific respiratory phases. However, lateral inhibition was not uniformly larger during a particular respiratory phase in either cell type. Removing nasal airflow abolished respiration-coupled spiking in both cell types and nearly eliminated spiking in mitral, but not tufted, cells. In the absence of nasal airflow, lateral inhibition was weaker in mitral cells and less modulated in tufted cells. Thus, respiration drives distinct network activities that functionally modulate sensory processing in the OB.