Morphogens, growth factors and extracellular matrix (ECM) components modulate early lung branching, and have been studied extensively both in vivo and in vitro. In vitro studies have been particularly useful, because tissue can be manipulated either chemically or mechanically. For the most part, such studies have been conducted at ambient oxygen tensions, despite the fact that the fetus develops in a low oxygen environment. Since oxygen tension regulates the expression of various growth factors, adhesion molecules and their receptors, we investigated whether the low oxygen environment of the fetus contributes towards lung branching morphogenesis by affecting one or more these mediators. Using an established fetal lung explant model, we demonstrated that in comparison to tissues cultured at ambient oxygen concentration (21% O2), fetal lung explants cultured at 3% O2 show increases in terminal branching and cellular proliferation, and they display appropriate proximal to distal differentiation. To investigate the factor(s) mediating the induction of lung branching morphogenesis and differentiation by fetal oxygen tension, we focused on matrix metalloproteinases (MMPs), a group of zinc-dependent enzymes that modify ECM structure and function. Our results reveal that hypoxia suppresses MMP activity, leading to the accumulation of specific ECM components, including tenascin-C (TN-C), that act to stimulate lung branching. These studies demonstrate that low oxygen in the setting of the developing lung positively regulates lung branching morphogenesis, and suggest that the pathologic responses to low oxygen in the adult lung reflect a dysregulation of this lung developmental program.