This study examined the interaction between speech perception and lexical information among a group of 7-year-old children, of which 26 were poor readers and 36 were good readers. The children's performance was examined on tasks assessing reading skill, phonological awareness, pseudoword repetition, and phoneme identification. Although good readers showed clearly defined categorical perception in the phoneme identification task for both the /bif/-/pif/ and the /bis/-/pis/ continua, the category boundary for /bif/-/pif/ was at longer VOTs than the boundary for /bis/-/pis/, which characterizes the classic lexicality effect. Poor readers showed less sharply defined categorical perception on both continua. Although poor readers did not show the classic lexicality effect, lexicality did affect the overall rate with which phonemes were identified as /b/ or /p/ at each VOT. These findings suggest that the lexicon may operate as a compensatory mechanism for resolving ambiguities in speech perception. Furthermore, statistical correction for group differences in phoneme identification made group differences in phoneme deletion disappear, suggesting that deficits in speech perception may play a causal role in the phonological core deficit associated with reading failure.