Ventral midline cells in the neural tube have distinct properties at different rostrocaudal levels, apparently in response to differential signalling by axial mesoderm. Floor plate cells are induced by sonic hedgehog (SHH) secreted from the notochord whereas ventral midline cells of the rostral diencephalon (RDVM cells) appear to be induced by the dual actions of SHH and bone morphogenetic protein 7 (BMP7) from prechordal mesoderm. We have examined the cellular and molecular events that govern the program of differentiation of RDVM cells under the influence of the axial mesoderm. By fate mapping, we show that prospective RDVM cells migrate rostrally within the neural plate, passing over rostral notochord before establishing register with prechordal mesoderm at stage 7. Despite the co-expression of SHH and BMP7 by rostral notochord, prospective RDVM cells appear to be specified initially as caudal ventral midline neurectodermal cells and to acquire RDVM properties only at stage 7. We provide evidence that the signalling properties of axial mesoderm over this period are regulated by the BMP antagonist, chordin. Chordin is expressed throughout the axial mesoderm as it extends, but is downregulated in prechordal mesoderm coincident with the onset of RDVM cell differentiation. Addition of chordin to conjugate explant cultures of prechordal mesoderm and neural tissue prevents the rostralization of ventral midline cells by prechordal mesoderm. Chordin may thus act to refine the patterning of the ventral midline along the rostrocaudal axis.