Carboxy-terminal binding protein (CtBP) is a well-known corepressor of several DNA binding transcription factors in Drosophila as well as in mammals. CtBP is implicated in Polycomb Group (PcG) complex-mediated transcriptional repression because it can bind to some PcG proteins, and mutation of the ctbp gene in flies results in lost PcG protein recruitment to Polycomb Response Elements (PREs) and lost PcG repression. However, the mechanism of reduced PcG DNA binding in CtBP mutant backgrounds is unknown. We show here that in a Drosophila CtBP mutant background, intergenic transcripts are induced across several PRE sequences and this corresponds to reduced DNA binding by PcG proteins Pleiohomeotic (PHO) and Polycomb (Pc), and reduced trimethylation of histone H3 on lysine 27, a hallmark of PcG repression. Restoration of CtBP levels by expression of a CtBP transgene results in repression of intergenic transcripts, restored PcG binding, and elevated trimethylation of H3 on lysine 27. Our results support a model in which CtBP regulates expression of intergenic transcripts that controls DNA binding by PcG proteins and subsequent histone modifications and transcriptional activity.