When children hear a novel word in a context presenting a novel object and a familiar one, they usually assume that the novel word refers to the novel object. In a series of experiments, we tested whether this behavior would be found when 2-year-olds interpreted novel words that differed phonologically from familiar words in only 1 sound, either a vowel or consonant. Under these conditions children almost always chose the familiar object, though examination of eye movements showed that children did detect the tested phonological distinctions. Thus, children discounted perceptible phonological variations when doing so permitted a resolution of the speaker’s meaning without postulating a new word. Children with larger vocabularies made novel-word interpretations more often than children with smaller vocabularies did. The results suggest that although young children do interpret speech in terms of a learned phonological system, this does not mean that children assume that phonological distinctions imply lexical distinctions.