The zona limitans intrathalamica (ZLI) is located at the border between the prospective ventral thalamus and dorsal thalamus, and functions as a diencephalic signaling center. Little is known about the mechanism controlling ZLI formation. Using a combination of fate-mapping studies and in vitro assays, I show that the differentiation of the ZLI from progenitor cells in the alar plate is initiated by a Shh-dependent signal from the basal plate. The subsequent dorsal progression of ZLI differentiation requires ongoing Shh signaling, and is constrained by inhibitory factors derived from the dorsal diencephalon. These studies demonstrate that self-organizing signals from the basal plate regulate the formation of a potential patterning center in the ZLI in an orthogonal orientation in the alar plate, and thus create the potential for coordinated thalamic patterning in two dimensions.