In our previous study, we reported that a novel endophytic bacterium Bacillus oryzicola YC7007 has suppressed bacterial diseases of rice via induced systemic resistance and antibiotic production. This endophytic strain, B. oryzicola YC7007 was used as a biological control agent against bakanae disease of rice caused by Fusarium fujikuroi, and its mechanism of interaction with the pathogen and the rice was further elucidated. Root drenching with B. oryzicola YC7007 suspension reduced the disease severity of bakanae significantly when compared with the untreated controls. The treatments of B. oryzicola YC7007 suspension (2.0 × 107 cfu/ml) to the rice rhizosphere reduced bakanae severity by 46–78% in pots and nursery box tests containing autoclaved and non-autoclaved soils. Moreover, in the detached rice leaves bioassay, the development of necrotic lesion and mycelial expansion of F. fujikuroi were inhibited significantly by spraying the culture filtrate of B. oryzicola YC7007. Drenching of ethyl acetate extracts of the culture filtrate to the rhizosphere of rice seedlings also reduced the bakanae disease severity in the plant culture dish tests. With the root drenching of B. oryzicola YC7007 suspension, the accumulation of hydrogen peroxide was observed at an early stage of rice seedlings, and a hormonal defense was elicited with and without pathogen inoculation. Our results showed that the strain B. oryzicola YC7007 had a good biocontrol activity against the bakanae disease of rice by direct inhibition, and was also capable of inducing systemic resistance against the pathogen via primed induction of the jasmonic acid pathway.