The transcription factor FoxA2 is a master regulator of endoderm development and pancreatic beta cell gene expression. To elucidate the mechanisms underlying the activation of the FoxA2 gene during differentiation, we have compared the epigenetic status of undifferentiated human embryonic stem cells (hESCs), hESC-derived early endoderm stage cells (CXCR4+ cells) and pancreatic islet cells. Unexpectedly, a CpG island in the promoter region of the FoxA2 gene displayed paradoxically high levels of DNA methylation in expressing tissues (CXCR4+, islets), and low levels in non-expressing tissues. This CpG island region was found to repress reporter gene expression, and bind the Polycomb group protein SUZ12 and the DNA methyltransferase DNMT3b preferentially in undifferentiated hESCs as compared to CXCR4+ or islets cells. Consistent with this, activation of FoxA2 gene expression, but not CXCR4 or SOX17, was strongly inhibited by 5-aza-2'-deoxycytidine, and by knock down of DNMT3b. We hypothesize that in non-expressing tissues, lack of DNA methylation allows the binding of DNA methyltransferases and repressing proteins such as Polycomb group proteins; upon differentiation, DNMT activation leads to CpG island methylation, causing loss of repressor protein binding. These results suggest a novel and unexpected role for DNA methylation in activation of FoxA2 gene expression during differentiation.