The Wingless (Wg)/Wnt signal transduction pathway regulates many developmental processes through a complex of Armadillo(Arm)/beta-catenin and the HMG-box transcription factors of the Tcf family. We report the identification of a new component, Pygopus (Pygo), that plays an essential role in the Wg/Wnt signal transduction pathway. We show that Wg signaling is diminished during embryogenesis and imaginal disc development in the absence of pygo activity. Pygo acts downstream or in parallel with Arm to regulate the nuclear function of Arm protein. pygo encodes a novel and evolutionarily conserved nuclear protein bearing a PHD finger that is essential for its activity. We further show that Pygo can form a complex with Arm in vivo and possesses a transcription activation domain(s). Finally, we have isolated a Xenopus homolog of pygo (Xpygo). Depletion of maternal Xpygo by antisense deoxyoligonucleotides leads to ventralized embryonic defects and a reduction of the expression of Wnt target genes. Together, these findings demonstrate that Pygo is an essential component in the Wg/Wnt signal transduction pathway and is likely to act as a transcription co-activator required for the nuclear function of Arm/beta-catenin.