Hepadnaviruses encode two core-related open reading frames. One directs the synthesis of the p21 core protein, which subsequently becomes a structural component of the viral nucleocapsid. The other produces a p25 precore protein that is targeted by a signal peptide to a cell secretory pathway where N-terminal processing will create a p22 species. This molecule will be further modified at the C-terminal region to generate p17, and the truncated protein is secreted from the cell as hepatitis B e antigen (HBeAg). The function of the precore gene in the biology of hepadnaviruses is unknown. We found that ablation of the precore gene resulted in the generation of a hepatitis B virus (HBV) species with a high-replication-level phenotype. More important, expression in trans of physiologic levels of p25 restored viral replication to wild-type levels. Moreover, transient or stable overexpression of the precore gene resulted in striking inhibition of HBV replication. The molecular species responsible for this viral inhibitory effect was identified as the p22 nonsecreted HBeAg precursor protein. By sucrose gradient sedimentation analysis, we determined that expression of p22 leads to the formation of nucleocapsids similar to those made with wild-type p21 core protein. Immunoprecipitation experiments revealed that the p21 and p22 physically interact and form hybrid nucleocapsid structures devoid of pregenomic viral RNA. These experiments suggest that expression of the precore gene may be important in the regulation of HBV replication and describe a possible molecular mechanism(s) for this effect.