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Guaianolides are an important class of sesquiterpene lactones with unique biological and pharmaceutical properties. They have been postulated to be derived from germacranolides, but for years no progress has been made in the elucidation of their biosynthesis that requires an unknown cyclization mechanism. Here we demonstrate the isolation and characterization of a cytochrome P450 from feverfew (Tanacetum parthenium), kauniolide synthase. Kauniolide synthase catalyses the formation of the guaianolide kauniolide from the germacranolide substrate costunolide. Unlike most cytochrome P450s, kauniolide synthase combines stereoselective hydroxylation of costunolide at the C3 position, with water elimination, cyclization and regioselective deprotonation. This unique mechanism of action is supported by in silico modelling and docking experiments. The full kauniolide biosynthesis pathway is reconstructed in the heterologous hosts Nicotiana benthamiana and yeast, paving the way for biotechnological production of guaianolide-type sesquiterpene lactones.