Extracellular gradients of signalling molecules can specify different thresholds of gene activity in development. A gradient of Decapentaplegic (Dpp) activity subdivides the dorsal ectoderm of the Drosophila embryo into amnioserosa and dorsal epidermis. The proteins Short gastrulation (Sog) and Tolloid (Tld) are required to shape this gradient. Sog has been proposed to form an inhibitory complex with either Dpp or the related ligand Screw, and is subsequently processed by the protease Tld. Paradoxically, Sog appears to be required for amnioserosa formation, which is specified by peak Dpp signalling activity. Here we show that the misexpression of sog using the even-skipped stripe-2 enhancer redistributes Dpp signalling in a mutant background in which dpp is expressed throughout the embryo. Dpp activity is diminished near the Sog stripe and peak Dpp signalling is detected far from this stripe. However, a tethered form of Sog suppresses local Dpp activity without augmenting Dpp activity at a distance, indicating that diffusion of Sog may be required for enhanced Dpp activity and consequent amnioserosa formation. The long-distance stimulation of Dpp activity by Sog requires Tld, whereas Sog-mediated inhibition of Dpp does not. The heterologous Dpp inhibitor Noggin inhibits Dpp signalling but fails to augment Dpp activity. These results suggest an unusual strategy for generating a gradient threshold of growth-factor activity, whereby Sog and its protease specify peak Dpp signalling far from a localized source of Sog.