In this study, we examined the mechanism for the relationship between morphological awareness and Chinese character reading in a group of Hong Kong primary school children when they were in grade two (n = 176, mean age = 8.07) and grade three (n = 163, mean age = 9.02). The results showed that morphological awareness, morpheme family size and the interaction effect of the two were all significant predictors of character reading in concurrent and longitudinal models. The interaction effect of morphological awareness and morpheme family size indicated that for morphemes with small family sizes, morphological awareness contributed more to character reading; for morphemes with large family sizes, it contributed less to character reading. The results suggested that one mechanism for the relationship between morphological awareness and character reading in Chinese children is that morphological awareness helps children to retrieve the word-internal context during character learning.