Due to their immunomodulatory functions, mesenchymal stem cells (MSCs) have great potential for clinical applications to prevent rejection in organ transplantation and to prevent graft-versus-host disease in hematopoietic stem cell (HSC) transplantation. Since dendritic cells (DCs) play an important role in modulating diverse T cell responses, including rejection and graft-versus-host disease, the goal of this study was to investigate whether MSCs modulate DC differentiation from HSCs and if this effect could be one of the mechanisms for MSCs' immune-modulating functions. Our results demonstrate that differentiation of HSCs into mature DCs is inhibited in the presence of MSCs. Similar frequency of dendritic precursors in the cultures, either with or without MSCs, suggests that the inhibition of MSCs on the differentiation of mature DCs from HSCs could be due to the arresting of maturation at the dendritic precursor step. Reduced levels of cyclic AMP, adenosine 3',5'-cyclic monophosphate (cAMP) and beta-catenin in DC-like cells from the cocultures are detected, suggesting that induction of apoptosis and inhibition of differentiation could be the basis for the inhibition of mature DCs from HSCs by MSCs. Further, our results demonstrate that DCs derived from HSCs in the presence of MSCs are functionally impaired, especially for those after direct contact with MSCs. To investigate the basis of functional impairment, our data show downregulated tumor necrosis factor-alpha and transforming growth factor-beta1 secretion and upregulated interleukin-6 (IL6) and IL1beta secretion in the cultures with MSCs. Together, MSCs can inhibit differentiation of mature DCs from HSCs by arresting them at the precursor stage and induce their apoptosis. Further, HSC-derived DCs in the presence of MSCs are functionally impaired, which could be partly due to the upregulation of IL6 secretion.