ABSTRACT Like the neuroblasts of the central nervous system, sensory organ precursors of the peripheral nervous system of the Drosophila thorax arise as single spaced cells. However, groups of cells initially have neural potential as visualized by the expression of the proneural genes achaete and scute. A class of genes, known as the ‘neurogenic genes’, function to restrict the proportion of cells that differentiate as sensory organ precursors. They mediate cell communication between the competent cells by means of an inhibitory signal, Delta, that is transduced through the Notch receptor and results in a cessation of achaete-scute activity. Here we show that mutation of either the bHLH-encoding genes of the Enhancer of split complex (E(spl)-C) or groucho, like Notch or Delta mutants, cause an overproduction of sensory organ precursors at the expense of epidermis. The mutant cells behave autonomously suggesting that the corresponding gene products are required for reception of the inhibitory signal. Epistasis experiments place both E(spl)-C bHLH-encoding genes and groucho downstream of Notch and upstream of achaete and scute, consistent with the idea that they are part of the Notch signalling cascade. Since all competent cells produce both the receptor and its ligand, it was postulated that Notch and Delta are linked within each cell by a feedback loop. We show, that, like mutant Notch cells, cells mutant for E(spl)-C bHLH-encoding genes or groucho inhibit neighbouring wild-type cells causing them to adopt the epidermal fate. This inhibition requires the genes of the achaete-scute complex (AS-C) which must therefore regulate the signal Delta. Thus there is a regulatory loop between Notch and Delta that is under the transcriptional control of the E(spl)-C and AS-C genes.