Members of the Wnt/Wingless (Wg) family of signalling proteins organize many aspects of animal development by regulating the expression of particular target genes in responding cells. Recent biochemical studies indicate that the vertebrate HMG-domain proteins Lef-1 and XTcf-3 can physically interact with beta-catenin, a homologue of Drosophila Armadillo (Arm), the most downstream component known in the Wnt signal transduction pathway. However, these studies do not address whether the endogenous Lef/Tcf family members are required in vivo to transduce Wnt signals. Using genetic methods in Drosophila, we define a new segment polarity gene, pangolin (pan), and show that its product is required in vivo for Wg signal transduction in embryos and in developing adult tissues. In addition, we show that pan encodes a Lef/Tcf homologue and provide evidence that its protein product binds to the beta-catenin homologue Armadillo in vivo. Finally, we demonstrate that Pan functions downstream of Arm to transduce the Wg signal. Thus, our results indicate that Pan is an essential component of the Wg transduction pathway and suggest that it acts directly to regulate gene transcription in response to Wg signalling.