Human genetic evidence demonstrates that WNT1 mutations cause osteogenesis imperfecta (OI) and early‐onset osteoporosis, implicating WNT1 as a major regulator of bone metabolism. However, its main cellular source and mechanisms of action in bone remain elusive. We generated global and limb bud mesenchymal cell–targeted deletion of Wnt1 in mice. Heterozygous deletion of Wnt1 resulted in mild trabecular osteopenia due to decreased osteoblast function. Targeted deletion of Wnt1 in mesenchymal progenitors led to spontaneous fractures due to impaired osteoblast function and increased bone resorption, mimicking the severe OI phenotype in humans with homozygous WNT1 mutations. Importantly, we showed for the first time that Wnt1 signals strictly in a juxtacrine manner to induce osteoblast differentiation and to suppress osteoclastogenesis, in part via canonical Wnt signaling. In conclusion, mesenchymal cell‐derived Wnt1, acting in short range, is an essential regulator of bone homeostasis and an intriguing target for therapeutic interventions for bone diseases.