In the early zebrafish embryo, a ventral to dorsal gradient of bone morphogenetic protein (BMP) activity is established, which is essential for the specification of cell fates along this axis. To visualise and mechanistically determine how this BMP activity gradient forms, we have used a transgenic zebrafish line that expresses monomeric red fluorescent protein (mRFP) under the control of well-characterised BMP responsive elements. We demonstrate that mRFP expression in this line faithfully reports BMP and GDF signalling at both early and late stages of development. Taking advantage of the unstable nature of mRFP transcripts, we use in situ hybridisation to reveal the dynamic spatio-temporal pattern of BMP activity and establish the timing and sequence of events that lead to the formation of the BMP activity gradient. We show that the BMP transcriptional activity gradient is established between 30% and 40% epiboly stages and that it is preceded by graded mRNA expression of the BMP ligands. Both Dharma and FGF signalling contribute to graded bmp transcription during these early stages and it is subsequently maintained through autocrine BMP signalling. We show that BMP2B protein is also expressed in a gradient as early as blastula stages, but do not find any evidence of diffusion of this BMP to generate the BMP transcriptional activity gradient. Thus, in contrast to diffusion/transport-based models of BMP gradient formation in Drosophila, our results indicate that the establishment of the BMP activity gradient in early zebrafish embryos is determined by graded expression of the BMP ligands.