The mammary glands develop initially as buds arising from the ventral embryonic epidermis. Recent work has shed light on signaling pathways leading to the patterning and formation of the mammary placodes and buds in mouse embryos. Relatively little is known of the signaling pathways that initiate branching morphogenesis and the formation of the ducts from the embryonic buds. Previous studies have shown that parathyroid hormone-related protein (PTHrP; also known as parathyroid hormone-like peptide, Pthlh) is produced by mammary epithelial cells and acts on surrounding mesenchymal cells to promote their differentiation into a mammary-specific dense mesenchyme. As a result of PTHrP signaling, the mammary mesenchyme supports mammary epithelial cell fate, initiates ductal development and patterns the overlying nipple sheath. In this report, we demonstrate that PTHrP acts, in part, by sensitizing mesenchymal cells to BMP signaling. PTHrP upregulates BMP receptor 1A expression in the mammary mesenchyme, enabling it to respond to BMP4, which is expressed within mesenchymal cells underlying the ventral epidermis during mammary bud formation. We demonstrate that BMP signaling is important for outgrowth of normal mammary buds and that BMP4 can rescue outgrowth of PTHrP(-/-) mammary buds. In addition, the combination of PTHrP and BMP signaling is responsible for upregulating Msx2 gene expression within the mammary mesenchyme, and disruption of the Msx2 gene rescues the induction of hair follicles on the ventral surface of mice overexpressing PTHrP in keratinocytes (K14-PTHrP). Our data suggest that PTHrP signaling sensitizes the mammary mesenchyme to the actions of BMP4, triggering outgrowth of the mammary buds and inducing MSX2 expression, which, in turn, leads to lateral inhibition of hair follicle formation within the developing nipple sheath.