We have analyzed the effects of vaccinia virus (VV) on gamma interferon (IFN-␥) signal transduction. Infection of cells with VV 1 to 2 h prior to treatment with IFN-␥ inhibits phosphorylation and nuclear translocation of Stat1 and consequently blocks accumulation of mRNAs normally induced by IFN-␥. While phosphorylation of other proteins in the IFN-␥ pathway was not affected, activation of Stat1 by other ligandreceptor systems was also blocked by VV. This block of Stat1 activation was dose dependent, and although viral protein synthesis was not required, entry and uncoating of viral cores appear to be needed to block the accumulation of phosphorylated Stat1. These results suggest that a virion component is responsible for the effect. VV virions contain a phosphatase (VH1) that is sensitive to the phosphatase inhibitor Na 3 VO 4 but not to okadaic acid. Addition of Na 3 VO 4 but not okadaic acid restored normal Stat1 phosphorylation levels in VV-infected cells. Moreover, virions containing reduced levels of VH1 were unable to block the IFN-␥ signaling pathway. In vitro studies show that the phosphatase can bind and dephosphorylate Stat1, indicating that this transcription factor can be a substrate for VH1. Our results reveal a novel mechanism by which VV interferes with the onset of host immune responses by blocking the IFN-␥ signal cascade through the dephosphorylating activity of the viral phosphatase VH1.Gamma interferon (IFN-␥) plays a key role in host defense (67). It regulates the adaptive immune response by enhancing major histocompatibility complex (MHC) class I expression in most cells and inducing MHC class II expression in antigenpresenting cells and endothelial cells. It is also the major physiological activating factor of macrophages and is responsible for induction of nonspecific immune responses. IFN-␥ acts synergistically with tumor necrosis factor (cytotoxic activity/ inflammatory response) and IFN␣/ (antiviral activity). IFNs are essential and functionally nonredundant in successful host responses to certain viruses (48).IFN-␥ exerts its action through its ability to bind to the IFN-␥ receptor (IFN-␥R) and induce dimerization of receptor ␣ and  subunit pairs to form a heterotetramer (18,19). The IFN-␥R ␣ and  chains associate with Janus protein kinases Jak1 and Jak2, respectively (34,37,47,65). Ligand-induced association of the receptor subunits allows these kinases to phosphorylate the IFN-␥R␣. The phosphorylated tyrosine (PTyr) and adjacent residues constitute a docking site for the sh2 domain of Stat1 (p91) (16,22), which is present in the cytoplasm as a latent transcription factor. Once bound to the receptor-Jak complex, Stat1 is phosphorylated (p91-P) (57) and subsequently dissociates from the receptor and homodimerizes, by a process that is not fully understood, to form the IFN-␥ activation factor GAF. The IFN-␥ activation factor is translocated to the nucleus, where it is able to bind to the IFN-␥ activation sequence-GAS-in the promoters of genes whose expression is induced by IFN-␥ (5...