Cadherin-based intercellular adhesions are essential players in epithelial homeostasis, but their dynamic regulation during tissue morphogenesis and remodeling remain largely undefined. Herein, we characterize an unexpected role for the membrane-anchored metalloproteinase MT2-MMP in regulating epithelial cell quiescence. Following co-immunoprecipitation and mass spectrometry, the MT2-MMP cytosolic tail was found to interact with the zonula occludens protein-1 (ZO-1) at the apical junctions of polarized epithelial cells. Functionally, MT2-MMP localizes in the apical domain of epithelial cells where it cleaves E-cadherin and promotes epithelial cell accumulation, a phenotype observed in 2D polarized cells as well as 3D cysts. MT2-MMP-mediated cleavage subsequently disrupts apical E-cadherin-mediated cell quiescence resulting in; i) relaxed apical cortical tension favoring cell extrusion and ii) re-sorting of Src kinase activity to junctional complexes, thereby promoting proliferation. Physiologically, MT2-MMP loss-of-function alters E-cadherin distribution leading to impaired 3D organoid formation by mouse colonic epithelial cells ex vivo and reduction of cell proliferation within intestinal crypts in vivo. Taken together, these studies identify an MT2-MMP/E-cadherin axis that functions as a novel regulator of epithelial cell homeostasis in vivo.