The APOE4 allele is the strongest genetic risk factor for late-onset Alzheimer’s disease (AD). The contribution of microglial APOE4 to AD pathogenesis is unknown, although APOE has the most enriched gene expression in neurodegenerative microglia (MGnD). Here, we show in mice and humans a negative role of microglial APOE4 in the induction of the MGnD response to neurodegeneration. Deletion of microglial APOE4 restores the MGnD phenotype associated with neuroprotection in P301S tau transgenic mice and decreases pathology in APP/PS1 mice. MGnD–astrocyte cross-talk associated with β-amyloid (Aβ) plaque encapsulation and clearance are mediated via LGALS3 signaling following microglial APOE4 deletion. In the brains of AD donors carrying the APOE4 allele, we found a sex-dependent reciprocal induction of AD risk factors associated with suppression of MGnD genes in females, including LGALS3, compared to individuals homozygous for the APOE3 allele. Mechanistically, APOE4-mediated induction of ITGB8–transforming growth factor-β (TGFβ) signaling impairs the MGnD response via upregulation of microglial homeostatic checkpoints, including Inpp5d, in mice. Deletion of Inpp5d in microglia restores MGnD–astrocyte cross-talk and facilitates plaque clearance in APP/PS1 mice. We identify the microglial APOE4–ITGB8–TGFβ pathway as a negative regulator of microglial response to AD pathology, and restoring the MGnD phenotype via blocking ITGB8–TGFβ signaling provides a promising therapeutic intervention for AD.