Reciprocal epithelial-mesenchymal signaling is essential for morphogenesis, including branching of the lung. In the mouse, mesenchymal cells differentiate into airway smooth muscle that wraps around epithelial branches, but this contractile tissue is absent from the early avian lung. Here, we have found that branching morphogenesis in the embryonic chicken lung requires extracellular matrix (ECM) remodeling driven by reciprocal interactions between the epithelium and mesenchyme. Before branching, the basement membrane wraps the airway epithelium as a spatially uniform sheath. After branch initiation, however, the basement membrane thins at branch tips; this remodeling requires mesenchymal expression of matrix metalloproteinase 2, which is necessary for branch extension but for not branch initiation. As branches extend, tenascin C (TNC) accumulates in the mesenchyme several cell diameters away from the epithelium. Despite its pattern of accumulation, TNC is expressed exclusively by epithelial cells. Branch extension coincides with deformation of adjacent mesenchymal cells, which correlates with an increase in mesenchymal fluidity at branch tips that may transport TNC away from the epithelium. These data reveal novel epithelial-mesenchymal interactions that direct ECM remodeling during airway branching morphogenesis.