Loss of alveolar type 2 cells (AEC2s) and the ectopic appearance of basal cells in the alveoli characterize severe lung injuries such as idiopathic pulmonary fibrosis (IPF). Here we demonstrate that human alveolar type 2 cells (hAEC2s), unlike murine AEC2s, transdifferentiate into basal cells in response to fibrotic signalling in the lung mesenchyme, in vitro and in vivo. Single-cell analysis of normal hAEC2s and mesenchymal cells in organoid co-cultures revealed the emergence of pathologic fibroblasts and basaloid cells previously described in IPF. Transforming growth factor-β1 and anti-bone morphogenic protein signalling in the organoids promoted transdifferentiation. Trajectory and histologic analyses of both hAEC2-derived organoids and IPF epithelium indicated that hAEC2s transdifferentiate into basal cells through alveolar-basal intermediates that accumulate in proximity to pathologic CTHRC1^hi/TGFB1^hi fibroblasts. Our study indicates that hAEC2 loss and expansion of alveolar metaplastic basal cells in severe human lung injuries are causally connected through an hAEC2-basal cell lineage trajectory driven by aberrant mesenchyme.