The progressive generation of embryonic trunk structures relies on the proper patterning of the caudal epiblast, which involves the integration of several signalling pathways. We have investigated the function of retinoic acid (RA) signalling during this process. We show that, in addition to posterior mesendoderm, primitive streak and node cells transiently express the RA-synthesizing enzyme Raldh2 prior to the headfold stage. RA-responsive cells (detected by the RA-activated RARE-lacZ transgene) are additionally found in the epiblast layer. Analysis of RA-deficient Raldh2(-/-) mutants reveals early caudal patterning defects, with an expansion of primitive streak and mesodermal markers at the expense of markers of the prospective neuroepithelium. As a result, many genes involved in neurogenesis and/or patterning of the embryonic spinal cord are affected in their expression. We demonstrate that RA signalling is required at late gastrulation stages for mesodermal and neural progenitors to respond to the Shh signal. Whole-embryo culture experiments indicate that the proper response of cells to Shh requires two RA-dependent mechanisms: (1) a balanced antagonism between Fgf and RA signals, and (2) a RA-mediated repression of Gli2 expression. Thus, an interplay between RA, Fgf and Shh signalling is likely to be an important mechanism underpinning the tight regulation of caudal embryonic development.