Influenza virus utilizes a unique mechanism for initiating the transcription of viral mRNA. The viral transcriptase ribonucleoprotein complex hydrolyzes host cell transcripts containing the cap 1 structure (m(7)GpppG(2'-OMe)-) to generate a capped primer for viral mRNA transcription. Basic aspects of this viral endonuclease reaction are elucidated in this study through the use of synthetic, radiolabeled RNA substrates and substrate analogs containing the cap 1 structure. Unlike most ribonucleases, this viral endonuclease is shown to catalyze the hydrolysis of the scissile phosphodiester, resulting in 5'-phosphate- and 3'-hydroxyl-containing fragments. Nevertheless, the 2'-OH adjacent to the released ribosyl 3'-OH is shown to be important for catalysis. In addition, while the endonuclease steady-state turnover rate is measured to be 2 h(-1), phosphodiester bond hydrolysis is not rate-limiting. The direct generation of a free 3'-OH and the subsequent slow release of this product are consistent with the viral need for efficient use of the capped primer in subsequent reactions of the influenza transcriptase complex.