The project will make engines for use in Peugeot, Citroen and future variants of the MINI vehicles and both manufacturers say the engine will benefit from the latest technology.
BMW's research and development department will be in charge of designing the engines and the common project will be based in Munich, Germany.
The deal puts the DaimlerChrysler's Brazilian built engine in the Mini under threat.
The Chrysler Group and BMW formed a joint venture in 1997 to build a manufacturing plant in Brazil to develop and produce 1.4-litre and 1.6-litre powerplants.
But in a statement, DaimlerChrysler said: 'The announcement is not expected to impact the current Tritec joint venture in Brazil during the current term of the contract.'
It added that the contract is due to expire 'later in the decade' and that the 1.6-litre Tritec engine is also used by Chrysler Group in Neons and PT Cruisers sold in Europe.
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