Background Cartilage defects are common and causes osteoarthritis. Articular chondrocytes or bone marrow-derived stromal cells are presently the favoured cells for cartilage tissue engineering. Human umbilical cord blood multilineage progenitor cells (MLPCs) are easily harvested and have capability for chondrogenic differentiation. According to recent studies combined three-dimensional (3D) culturing in low oxygen tension enhances differentiation. Aim This study evaluates the chondrogenic potential of MLPC culturing in a novel 3D-scaffold of polycaprolactone and 5% O2. Materials and methods MLPCs were induced in conventional 3D pellets or on scaffolds in 5% O2 or 21% O2. Culturing in 21% O2 and non-inductive chondrogenic medium was used as control. Gene expression of aggrecan, SOX9, CD-RAP, collagen I, II and X was evaluated. Matrix deposition was visualized by histological staining with H&E and Alcian blue. Sulphated glycosaminoglycans (sGAG) and secreted CD-RAP were assessed as markers of cartilage anabolism. Results MLPCs pellets and scaffolds induced in 5% O2 showed increased cellularity and matrix deposition compared with induction in 21% O2. Matrix deposition in pellets was observed in a zonal pattern in relation to the oxygen tension. Induced scaffolds showed cellularity and matrix deposition superficially and to adjacent scaffold fibres. Induced MLPCs pellets and scaffolds had significantly higher gene expression of aggrecan, SOX9, CD-RAP, collagen I, II and X compared with controls. Ratios of collagen II/I and collagen II/X was increased in 5% O2. Induced MLPCs in 5% O2 accumulated significantly higher levels of sGAG and CD-RAP. Conclusion The importance of low oxygen in MLPCs differentiation is insufficiently covered in literature. In this current study, 5% O2 apparently favours chondrogenic differentiation. Furthermore, combined culturing of MLPCs in a 3D polycaprolactone scaffold and 5% O2 enhanced and stabilized the chondrocyte phenotype.