Sprouty (Spry) inhibits signalling by receptor tyrosine kinases; however, the molecular mechanism underlying this function has not been defined. Here we show that after stimulation by growth factors Spry1 and Spry2 translocate to the plasma membrane and become phosphorylated on a conserved tyrosine. Next, they bind to the adaptor protein Grb2 and inhibit the recruitment of the Grb2–Sos complex either to the fibroblast growth factor receptor (FGFR) docking adaptor protein FRS2 or to Shp2. Membrane translocation of Spry is necessary for its phosphorylation, which is essential for its inhibitor activity. A tyrosine-phosphorylated octapeptide derived from mouse Spry2 inhibits Grb2 from binding FRS2, Shp2 or mouse Spry2 in vitro and blocks activation of the extracellular-signal-regulated kinase (ERK) in cells stimulated by growth factor. A non-phosphorylated Spry mutant cannot bind Grb2 and acts as a dominant negative, inducing prolonged activation of ERK in response to FGF and promoting the FGF-induced outgrowth of neurites in PC12 cells. Our findings suggest that Spry functions in a negative feedback mechanism in which its inhibitor activity is controlled rapidly and reversibly by post-translational mechanisms.