Mesenchymal stem cells (MSCs) are multipotent cells capable of developing along the chondrogenic, osteogenic and adipogenic lineages. As such, they have received interest as a potential cell source for tissue engineering strategies. Cartilage is an avascular tissue and thus resides in a microenvironment with reduced oxygen tension. The aim of this study was to examine the effect of a low oxygen environment on MSC differentiation along the chondrogenic route. In MSCs exposed to chondrogenic growth factors, transforming growth factor-beta and dexamethasone, in a hypoxic environment (2% oxygen), the induction of collagen II expression and proteoglygan deposition was significantly greater than that observed when cells were exposed to the chondrogenic growth factors under normoxic (20% oxygen) conditions. The transcription factor, hypoxia-inducible factor-1alpha (HIF-1alpha), is a crucial mediator of the cellular response to hypoxia. Following exposure of MSCs to hypoxia (2% oxygen), HIF-1alpha translocated from the cytosol to the nucleus and bound to its target DNA consensus sequence. Similarly, hypoxia evoked an increase in phosphorylation of both AKT and p38 mitogen activated protein kinase, upstream of HIF-1alpha activation. Furthermore, the PI3 kinase/AKT inhibitor, LY294002, and p38 inhibitor, SB 203580, prevented the hypoxia-mediated stabilisation of HIF-1alpha. To assess the role of HIF-1alpha in the hypoxia-induced increase in chondrogenesis, we employed an siRNA knockdown approach. In cells exposed to HIF-1alpha siRNA, the hypoxia-induced enhancement of chondrogenesis, as evidenced by upregulation of collagen II, sox-9 and proteoglycan deposition, was absent. This provides evidence for HIF-1alpha being a key mediator of the beneficial effect of a low oxygen environment on chondrogenesis.