Mesenchymal stem cells (MSCs), derived from adult tissues, are multipotent progenitor cells, which hold great promise for regenerative medicine. Recent studies have shown that MSCs are immunosuppressive in vivo and in vitro in both animals and humans. However, the mechanisms that govern these immune modulatory functions of MSCs remain largely elusive. Some studies with bulk populations of MSCs indicated that soluble factors such as PGE2 and TGFbeta are important, while others support a role for cell-cell contact. In this study, we intended to clarify these issues by examining immunosuppressive effects of cloned MSCs. We derived MSC clones from mouse bone marrow and showed that the majority of these clones were able to differentiate into adipocytes and osteoblast-like cells. Importantly, cells from these clones exhibited strong inhibitory effects on TCR activation-induced T cell proliferation in vitro, and injection of a small number of these cells promoted the survival of allogeneic skin grafts in mice. Conditioned medium from MSC cultures showed some inhibitory effect on anti-CD3 induced lymphocyte proliferation independent of PGE2 and TGFbeta. In comparison, direct co-culture of MSCs with stimulated lymphocytes resulted in much stronger immunosuppressive effect. Interestingly, the suppression was bi-directional, as MSC proliferation was also reduced in the presence of lymphocytes. Taking together, our findings with cloned MSCs demonstrate that these cells exert their immunosuppressive effects through both soluble factor(s) and cell-cell contact, and that lymphocytes and MSCs are mutually inhibitory on their respective proliferation.