Abstract Increasing drought stress poses a severe threat to agricultural productivity. Plants, however, have evolved numerous mechanisms to cope with such environmental stress. Here we report that the stress-induced production of a peptide signal contributes to stress tolerance. The expression of phytosulfokine (PSK) peptide precursor genes, and transcripts of three subtilisin-like serine proteases, SBT1.4, SBT3.7, and SBT3.8, were found to be up-regulated in response to osmotic stress. Stress symptoms were more pronounced in sbt3.8 loss-of-function mutants and could be alleviated by PSK treatment. Osmotic stress tolerance was improved in plants overexpressing the PSK1 precursor (proPSK1) or SBT3.8, resulting in higher fresh weight and improved lateral root development in transgenic plants compared with wild-type plants. We further showed that SBT3.8 is involved in the biogenesis of the bioactive PSK peptide. ProPSK1 was cleaved by SBT3.8 at the C-terminus of the PSK pentapeptide. Processing by SBT3.8 depended on the aspartic acid residue directly following the cleavage site. ProPSK1 processing was impaired in the sbt3.8 mutant. The data suggest that increased expression of proPSK1 in response to osmotic stress followed by the post-translational processing of proPSK1 by SBT3.8 leads to the production of PSK as a peptide signal for stress mitigation.