Although most cells undergo growth arrest during hypoxia, endothelial cells and placental cytotrophoblasts proliferate in response to low O₂. We demonstrate that proliferation of embryonic multilineage hematopoietic progenitors is also regulated by a hypoxia-mediated signaling pathway. This pathway requires HIF-1 (HIF-1α/ARNT heterodimers) because Arnt^−/− embryoid bodies fail to exhibit hypoxia-mediated progenitor proliferation. Furthermore, Arnt^−/− embryos exhibit decreased numbers of yolk sac hematopoietic progenitors. This defect is cell extrinsic, is accompanied by a decrease in ARNT-dependent VEGF expression, and is rescued by exogenous VEGF. Therefore, “physiologic hypoxia” encountered by embryos is essential for the proliferation or survival of hematopoietic precursors during development.