Hepatitis C virus (HCV) infections are the major cause of chronic liver disease, cirrhosis and hepatocellular carcinoma worldwide. Both spontaneous and treatment induced clearance of HCV depend upon genetic variation within the interferon lambda locus, but until now no clear causal relationship has been established. We demonstrate that an amino acid substitution in the IFNλ4 protein changing a proline at position 70 to a serine (P70S) substantially alters its antiviral activity. Paradoxically the lower antiviral activity of the S70 version of IFNλ4 leads to an improved prognosis for HCV infected patients. Patients harboring the impaired IFNλ4-S70 variant display lower interferon-stimulated gene (ISG) expression levels, better treatment response rates and better spontaneous clearance rates, compared to patients coding for the fully active IFNλ4-P70 variant. High expression of Interferon Stimulated Genes (ISGs) in the liver of HCV infected patients are known to predict a poor response to interferon based treatments, however, the interferon driving this high ISG expression has not been identified. Our data provide compelling evidence that the active IFNλ4 protein is the driver of high hepatic ISG expression in HCV infected individuals as well as being the cause of poor HCV clearance.