Poly(ethylene glycol) PEG-based hydrogels are promising for cell encapsulation and tissue engineering， but are known to elicit a foreign body response (FBR) in vivo. The goal of this study was to investigate the impact of the FBR， and specifically the presence of inflammatory macrophages， on encapsulated cells and their ability to synthesize new extracellular matrix. This study employed an in vitro co-culture system with murine macrophages and MC3T3-E1 pre-osteoblasts encapsulated in a bone-mimetic hydrogel， which were cultured in transwell inserts， and exposed to an inflammatory stimulant， lipopolysaccharide (LPS). The co-culture was compared to mono-cultures of the cell-laden hydrogels alone and with LPS over 28?days. Two macrophage cell sources， RAW 264.7 and primary derived， were investigated. The presence of LPS-stimulated primary macrophages led to significant changes in the cell-laden hydrogel by a 5.3-fold increase in percent apoptotic osteoblasts at day 28， 4.2-fold decrease in alkaline phosphatase activity at day 10， and 7-fold decrease in collagen deposition. The presence of LPS-stimulated RAW macrophages led to significant changes in the cell-laden hydrogel by 5-fold decrease in alkaline phosphatase activity at day 10 and 4-fold decrease in collagen deposition. Mineralization， as measured by von Kossa stain or quantified by calcium content， was not sensitive to macrophages or LPS. Elevated interleukin-6 and tumor necrosis factor-α secretion were detected in mono-cultures with LPS and co-cultures. Overall， primary macrophages had a more severe inhibitory effect on osteoblast differentiation than the macrophage cell line， with greater apoptosis and collagen I reduction. In summary， this study highlights the detrimental effects of macrophages on encapsulated cells for bone tissue engineering.