A major therapeutic challenge is how to replace bone once it is lost. Bone loss is a characteristic of chronic inflammatory and degenerative diseases such as rheumatoid arthritis and osteoporosis. Cells and cytokines of the immune system are known to regulate bone turnover by controlling the differentiation and activity of osteoclasts, the bone resorbing cells. However, less is known about the regulation of osteoblasts (OB), the bone forming cells. This study aimed to investigate whether immune cells also regulate OB differentiation. Using in vitro cell cultures of human bone marrow-derived mesenchymal stem cells (MSC), it was shown that monocytes/macrophages potently induced MSC differentiation into OBs. This was evident by increased alkaline phosphatase (ALP) after 7 days and the formation of mineralised bone nodules at 21 days. This monocyte-induced osteogenic effect was mediated by cell contact with MSCs leading to the production of soluble factor(s) by the monocytes. As a consequence of these interactions we observed a rapid activation of STAT3 in the MSCs. Gene profiling of STAT3 constitutively active (STAT3C) infected MSCs using Illumina whole human genome arrays showed that Runx2 and ALP were up-regulated whilst DKK1 was down-regulated in response to STAT3 signalling. STAT3C also led to the up-regulation of the oncostatin M (OSM) and LIF receptors. In the co-cultures, OSM that was produced by monocytes activated STAT3 in MSCs, and neutralising antibodies to OSM reduced ALP by 50%. These data indicate that OSM, in conjunction with other mediators, can drive MSC differentiation into OB. This study establishes a role for monocyte/macrophages as critical regulators of osteogenic differentiation via OSM production and the induction of STAT3 signalling in MSCs. Inducing the local activation of STAT3 in bone cells may be a valuable tool to increase bone formation in osteoporosis and arthritis, and in localised bone remodelling during fracture repair.