The epithelial-mesenchymal interactions between keratinocyte stem cells and dermal papilla cells are crucial for normal development of the hair follicle as well as during hair cycling. During the cyclical re-growth of a new lower follicle, the multi-potent hair follicle stem cells are stimulated to proliferate and differentiate through interactions with the underlying mesenchymal dermal papilla cells. In order to characterize the events occurring during the process of epithelial stem cell fate determination, we utilized a co-culture system by incubating human hair follicle keratinocyte stem cells with dermal papilla cells. Using Genechip microarrays, we analyzed changes in gene expression within the stem cells upon co-culture with the dermal papilla over a five-day time-course. A number of important signaling pathways and growth factors were regulated. The hair-specific keratin 6hf (K6hf) gene proved a particularly good marker of hair differentiation, with a 7.9 fold increase in mRNA and resulting increased protein levels. The high expression of K6hf was unique to dermal papilla-induced keratinocyte differentiation since expression of K6hf was not induced by high calcium. Since the -catenin signaling pathway has been implicated in hair follicle development, we examined the role of -catenin in our system and demonstrate that -catenin/lef-1 signaling is required for dermal papilla induced hair differentiation.