Transforming growth factor-β1 (TGF-β1) is a chondrogenic factor and has been reported to be able to enhance chondrocyte differentiation from bone marrow mesenchymal stem cells (BMSCs). Here we investigate the molecular mechanism through which TGF-β1 chronically promotes the repair of cartilage defect and inhibit chondrocyte hypertrophy. Animal models of full thickness cartilage defects were divided into three groups: model group, BMSCs group (treated with BMSCs/calcium alginate gel) and BMSCs+TGF-β1 group (treated with Lentivirus-TGF-β1-EGFP transduced BMSCs/calcium alginate gel). 4 and 8weeks after treatment, macroscopic observation, histopathological study and quantitative reverse transcription-polymerase chain reaction (qRT-PCR) were done to analyze phenotypes of the animals. BMSCs were transduced with Lentivirus-TGF-β1-EGFP in vitro and Western blot analysis was performed. We found that TGF-β1-expressiing BMSCs improved the repair of the cartilage defect. The impaired cartilage contained higher amount of GAG and type II collagen and was integrated to the surrounding normal cartilage and higher content of GAG and type II collagen. The major events include increased expression of type II collagen following Smad2/3 phosphorylation, and inhibition of cartilage hypertrophy by increasing Yes-associated protein-1 (YAP-1) and inhibiting Runx2 and Col10 after the completion of chondrogenic differentiation. We conclude that TGF-β1 is beneficial to chondrogenic differentiation of BMSCs via canonical Smad pathway to promote early-repairing of cartilage defect. Furthermore, TGF-β1 inhibits chondrocyte hypertrophy by decreasing hypertrophy marker gene expression via Hippo signaling. Long-term rational use of TGF-β1 may be an alternative approach in clinic for cartilage repair and regeneration.