The transcription factors HNF1B and Pax2, co-expressed in the Wolffian duct and ureteric bud epithelia, play essential roles during the early steps of mouse kidney development. In humans, heterozygous mutations in these genes display a number of common kidney phenotypes, including hypoplasia and multicystic hypoplastic kidneys. Moreover, a high prevalence of mutations either in HNF1B or PAX2 has been observed in children with renal hypodysplasia. To gain a better understanding of Hnf1b and Pax2 interactions in vivo, we generated compound heterozygous mice for Hnf1b and Pax2 null alleles. We show here that compound heterozygous mutants display phenotypes similar to severe congenital anomalies of the kidney and the urinary tract (CAKUT), including strong hypoplasia of the kidneys, caudal ectopic aborted ureter buds, duplex kidneys, megaureters and hydronephrosis. At a molecular level, compound mutants show a delay in nephron segment and medullar interstitial differentiation, increased apoptosis and a transient decrease in Lim1 and Wnt4 expression. We also observe a perturbation of smooth muscle differentiation around the ureter associated with a local down-regulation in transcript levels of Bmp4 and Tbx18, two key regulators involved in ureter smooth muscle formation, thus explaining, at least in part, megaureters. These results together uncover a novel role of Hnf1b as a modifier of the Pax2 haplo-insufficient phenotype and show that these two transcription factors operate in common pathways governing both kidney morphogenesis and ureter differentiation. This mouse model should provide new insights into the pathogenic mechanisms of human CAKUT, the most frequent developmental defect identified in newborns.