Signal transducers and activators of transcription (STATs) comprise a family of cytoplasmic signaling proteins that participates in normal cellular responses to cytokines and growth factors. Frequently, however, constitutive activation of certain STAT family members, particularly Stat3, has accompanied a wide variety of human malignancies. To identify small molecule inhibitors of Stat3, we investigated the ability of the Stat3 SH2 domain-binding peptide, PY*LKTK (where Y* represents phosphotyrosine), to disrupt Stat3 activity in vitro. The presence of PY*LKTK, but not PYLKTK or PFLKTK, in nuclear extracts results in significant reduction in the levels of DNA binding activities of Stat3, to a lesser extent of Stat1, and with no effect on that of Stat5. Analyses of alanine scanning mutagenesis and deletion derivatives of PY*LKTK reveal that the Leu residue at the Y+1 position and a substituent at the Y-1 position (but not necessarily Pro) are essential for the disruption of active Stat3, thereby mapping the minimum active sequence to the tripeptide, XY*L. Studies involving bead-coupled PY*LKTK peptide demonstrate that this phosphopeptide directly complexes with Stat3 monomers in vitro, suggesting that PY*LKTK disrupts Stat3:Stat3 dimers. As evidence for the functional importance of peptide-directed inhibition of Stat3, PY*LKTK-mts (mts, membrane translocating sequence) selectively inhibits constitutive and ligand-induced Stat3 activation in vivo. Furthermore, PY*LKTK-mts suppresses transformation by the Src oncoprotein, which has been shown previously to require constitutive Stat3 activation. Altogether, we have identified a minimal peptide that inhibits Stat3 signaling and provides the conceptual basis for use of this peptide as a lead for novel peptidomimetic drug design.