The Sonic hedgehog (Shh) signalling pathway plays important roles during development and in cancer. Here we report a Shh-induced epigenetic switch that cooperates with Gli to control transcription outcomes. Before induction, poised Shh target genes are marked by a bivalent chromatin domain containing a repressive histone H3K27me3 mark and an active H3K4me3 mark. Shh activation induces a local switch of epigenetic cofactors from the H3K27 methyltransferase polycomb repressive complex 2 (PRC2) to an H3K27me3 demethylase Jmjd3/Kdm6b-centred coactivator complex. We also find that non-enzymatic activities of Jmjd3 are important and that Jmjd3 recruits the Set1/MLL H3K4 methyltransferase complexes in a Shh-dependent manner to resolve the bivalent domain. In vivo, changes of the bivalent domain accompanied Shh-activated cerebellar progenitor proliferation. Overall, our results reveal a regulatory mechanism that underlies the activation of Shh target genes and provides insight into the causes of various diseases and cancers exhibiting altered Shh signalling.