Sphingosine 1-phosphate (S1P) is a bioactive lipid whose levels are tightly regulated by its synthesis and degradation. Intracellularly, S1P is dephosphorylated by the actions of two S1P-specific phosphatases, sphingosine-1-phosphate phosphatases 1 and 2. To identify the physiological functions of S1P phosphatase 1, we have studied mice with its gene, Sgpp1, deleted. Sgpp1(-/-) mice appeared normal at birth, but during the 1st week of life they exhibited stunted growth and suffered desquamation, with most dying before weaning. Both Sgpp1(-/-) pups and surviving adults exhibited multiple epidermal abnormalities. Interestingly, the epidermal permeability barrier developed normally during embryogenesis in Sgpp1(-/-) mice. Keratinocytes isolated from the skin of Sgpp1(-/-) pups had increased intracellular S1P levels and displayed a gene expression profile that indicated overexpression of genes associated with keratinocyte differentiation. The results reveal S1P metabolism as a regulator of keratinocyte differentiation and epidermal homeostasis.