Hippocampal neurons activated during encoding drive the recall of contextual fear memory. Little is known about how such ensembles emerge during acquisition and eventually form the cellular engram. Manipulating the activity of granule cells (GCs) of the dentate gyrus (DG), we reveal a mechanism of lateral inhibition that modulates the size of the cellular engram. GCs engage somatostatin-positive interneurons that inhibit the dendrites of surrounding GCs. Our findings reveal a microcircuit within the DG that controls the size of the cellular engram and the stability of contextual fear memory.