Angiotensin II (Ang II) is known to play a pivotal role in the development of diabetic nephropathy. However, the precise mechanism of Ang II-mediated effects on diabetic nephropathy is still unknown. We have reported that Smad1 plays a key role in diabetic mesangial matrix expansion and directly regulates the transcription of type IV collagen (Col4) in vitro and in vivo. Here we examined the effect of Ang II on the expression of Smad1 and mesangial matrix expansion in streptozotocin (STZ)-induced diabetic rats in vivo, using Ang II type 1 receptor blocker, olmesartan. We also examined the signaling mechanism by which Ang II induces mesangial matrix expansion in vitro. Treatment of diabetic rats with low-dose olmesartan for 20 weeks reduced albuminuria and hyperfiltration without affecting blood pressure and inhibited mesangial matrix expansive changes and the expression of Col4 and smooth muscle alpha actin compared with those in untreated rats. Immunohistochemical staining and Western blotting showed that the increased expression of Smad1, phospho-Smad1, and phospho-Src was inhibited by olmesartan. Ang II induced Col4 synthesis and increased expression of phospho-Src and phospho-Smad1 in cultured mesangial cells, which was blocked by olmesartan. PP2, a Src tyrosine kinase inhibitor, and overexpression of dominant negative Src also reduced the phosphorylation of Smad1. Moreover, addition of small-interfering RNA against Src significantly reduced the phosphorylation of Smad1 and synthesis of Col4. Taken together, these results indicate that Ang II can regulate the development of mesangial matrix expansion in the early phase of diabetic nephropathy through Src and Smad1.