The Drosophila BMP, decapentaplegic (dpp), controls morphogenesis of the ventral adult head through expression limited to the lateral peripodial epithelium of the eye-antennal disc by a 3.5 kb enhancer in the 5' end of the gene. We recovered a 15 bp deletion mutation within this enhancer that identified a homeotic (Hox) response element that is a direct target of labial and the homeotic cofactors homothorax and extradenticle. Expression of labial and homothorax are required for dpp expression in the peripodial epithelium, while the Hox gene Deformed represses labial in this location, thus limiting its expression and indirectly that of dpp to the lateral side of the disc. The expression of these homeodomain genes is in turn regulated by the dpp pathway, as dpp signalling is required for labial expression but represses homothorax. This Hox-BMP regulatory network is limited to the peripodial epithelium of the eye-antennal disc, yet is crucial to the morphogenesis of the head, which fate maps suggest arises primarily from the disc proper, not the peripodial epithelium. Thus Hox/BMP interactions in the peripodial epithelium of the eye-antennal disc contribute inductively to the shape of the external form of the adult Drosophila head.