A fundamental question in hematopoietic development is how multipotent progenitors achieve precise identities, while the progenitors themselves maintain quiescence. In Drosophila melanogaster larvae, multipotent hematopoietic progenitors support the production of three lineages, exhibit quiescence in response to cues from a niche, and from their differentiated progeny. Infection by parasitic wasps alters the course of hematopoiesis. Here we address the role of Notch (N) signaling in lamellocyte differentiation in response to wasp infection. We show that Notch activity is moderately high and ubiquitous in all cells of the lymph gland lobes, with crystal cells exhibiting the highest levels. Wasp infection reduces Notch activity, which results in fewer crystal cells and more lamellocytes. Robust lamellocyte differentiation is induced even in N mutants. Using RNA interference knockdown of N, Serrate, and neuralized (neur), and twin clone analysis of a N null allele, we show that all three genes inhibit lamellocyte differentiation. However, unlike its cell-autonomous function in crystal cell development, Notch's inhibitory influence on lamellocyte differentiation is not cell autonomous. High levels of reactive oxygen species in the lymph gland lobes, but not in the niche, accompany N(RNAi)-induced lamellocyte differentiation and lobe dispersal. Our results define a novel dual role for Notch signaling in maintaining competence for basal hematopoiesis: while crystal cell development is encouraged, lamellocytic fate remains repressed. Repression of Notch signaling in fly hematopoiesis is important for host defense against natural parasitic wasp infections. These findings can serve as a model to understand how reactive oxygen species and Notch signals are integrated and interpreted in vivo.