FGF signaling is a central regulator of branching morphogenesis processes, such as angiogenesis or the development of branched organs including lung, kidney, and mammary gland. The formation of the air sac during the development of the Drosophila tracheal system is a powerful genetic model to investigate how FGF signaling patterns such emerging structures. This article describes the characterization of the Drosophila matrix metalloprotease Mmp2 as an extracellular inhibitor of FGF morphogenetic function. Mmp2 expression in the developing air sac is controlled by the Drosophila FGF homolog Branchless and then participates in a negative feedback and lateral inhibition mechanism that defines the precise pattern of FGF signaling. The signaling function for MMPs described here may not be limited to branching morphogenesis processes.