Recent neuroimaging studies have reported deficits in functional integration between prefrontal cortex and the hippocampal formation in schizophrenia. It is unclear whether these alterations are a consequence of chronic illness or its treatment, and whether they are also evident in non-psychotic subjects at increased risk of the disorder. We addressed these issues by investigating prefrontal–hippocampal interactions in patients with first episode schizophrenia and subjects with an At Risk Mental State (ARMS). Using functional Magnetic Resonance Imaging, we measured brain responses from 16 individuals with an ARMS, 10 patients with first episode schizophrenia and 14 healthy controls during a delayed matching to sample task. Dynamic causal modelling was used to estimate the effective connectivity between prefrontal cortex and anterior and posterior hippocampal regions. The normal pattern of effective connectivity from the right posterior hippocampus to the right inferior frontal gyrus was significantly decreased in both first episode patients and subjects with an ARMS (ANOVA; F = 8.16, P = 0.01). Interactions between the inferior frontal gyrus and the anterior part of the hippocampus did not differ across the three groups. Perturbed hippocampal–prefrontal interactions are evident in individuals at high risk of developing psychosis and in patients who have just developed schizophrenia. This suggests that it may be a correlate of increased vulnerability to psychosis and that it is not attributable to an effect of chronic illness or its treatment.