diff --git a/cmd/ftl/cmd_build.go b/cmd/ftl/cmd_build.go
index 01f5857fc2..e6eec2ea02 100644
--- a/cmd/ftl/cmd_build.go
+++ b/cmd/ftl/cmd_build.go
@@ -19,7 +19,7 @@ type buildCmd struct {
 func (b *buildCmd) Run(ctx context.Context, projConfig projectconfig.Config) error {
 	client := rpc.ClientFromContext[ftlv1connect.ControllerServiceClient](ctx)
 	if len(b.Dirs) == 0 && len(b.External) == 0 {
-		b.Dirs = projConfig.ModuleDirsOrDefault()
+		b.Dirs = projConfig.AbsModuleDirsOrDefault()
 		b.External = projConfig.ExternalDirs
 	}
 	if len(b.Dirs) == 0 && len(b.External) == 0 {
diff --git a/cmd/ftl/cmd_dev.go b/cmd/ftl/cmd_dev.go
index 6de51bb3c0..c964f7ff2a 100644
--- a/cmd/ftl/cmd_dev.go
+++ b/cmd/ftl/cmd_dev.go
@@ -28,7 +28,7 @@ type devCmd struct {
 
 func (d *devCmd) Run(ctx context.Context, projConfig projectconfig.Config) error {
 	if len(d.Dirs) == 0 && len(d.External) == 0 {
-		d.Dirs = projConfig.ModuleDirsOrDefault()
+		d.Dirs = projConfig.AbsModuleDirsOrDefault()
 		d.External = projConfig.ExternalDirs
 	}
 	if len(d.Dirs) == 0 && len(d.External) == 0 {
diff --git a/common/projectconfig/merge.go b/common/projectconfig/merge.go
index da7b4181c6..baf64b7445 100644
--- a/common/projectconfig/merge.go
+++ b/common/projectconfig/merge.go
@@ -1,5 +1,9 @@
 package projectconfig
 
+import (
+	"path/filepath"
+)
+
 // Merge configuration files.
 //
 // Config is merged left to right, with later files taking precedence over earlier files.
@@ -11,7 +15,24 @@ func Merge(paths ...string) (Config, error) {
 			return config, err
 		}
 		config = merge(config, partial)
+
+		// Make module-dirs absolute to mimic the behavior of the CLI
+		config.absModuleDirs = []string{}
+		for _, dir := range config.ModuleDirs {
+			if !filepath.IsAbs(dir) {
+				absDir := filepath.Join(filepath.Dir(path), dir)
+				config.absModuleDirs = append(config.absModuleDirs, absDir)
+			} else {
+				config.absModuleDirs = append(config.absModuleDirs, dir)
+			}
+		}
+
+		// If no module-dirs are defined, default to the directory of the config file
+		if len(config.absModuleDirs) == 0 {
+			config.absModuleDirs = []string{filepath.Dir(path)}
+		}
 	}
+
 	return config, nil
 }
 
diff --git a/common/projectconfig/projectconfig.go b/common/projectconfig/projectconfig.go
index dfa65c3b19..dce1180ef6 100644
--- a/common/projectconfig/projectconfig.go
+++ b/common/projectconfig/projectconfig.go
@@ -32,16 +32,12 @@ type Config struct {
 	ExternalDirs  []string                    `toml:"external-dirs"`
 	Commands      Commands                    `toml:"commands"`
 	FTLMinVersion string                      `toml:"ftl-min-version"`
+	absModuleDirs []string
 }
 
-// ModuleDirsOrDefault returns the module-dirs field from the ftl-project.toml, unless
+// AbsModuleDirsOrDefault returns the absolute path for the module-dirs field from the ftl-project.toml, unless
 // that is not defined, in which case it defaults to the root directory.
-func (c Config) ModuleDirsOrDefault() []string {
-	if len(c.ModuleDirs) > 0 {
-		return c.ModuleDirs
-	}
-	return []string{"."}
-}
+func (c Config) AbsModuleDirsOrDefault() []string { return c.absModuleDirs }
 
 // ConfigPaths returns the computed list of configuration paths to load.
 func ConfigPaths(input []string) []string {
@@ -136,6 +132,7 @@ func loadFile(path string) (Config, error) {
 		}
 		return Config{}, fmt.Errorf("unknown configuration keys: %s", strings.Join(keys, ", "))
 	}
+
 	return config, nil
 }
 
diff --git a/lsp/lsp.go b/lsp/lsp.go
index 0c9e2ea234..81dfa2cd0f 100644
--- a/lsp/lsp.go
+++ b/lsp/lsp.go
@@ -78,9 +78,12 @@ func (s *Server) post(err error) {
 	errUnspecified := []error{}
 
 	// Deduplicate and associate by filename.
-	for _, err := range ftlErrors.DeduplicateErrors(ftlErrors.UnwrapAll(err)) {
+	for _, e := range ftlErrors.DeduplicateErrors(ftlErrors.UnwrapAll(err)) {
+		if !ftlErrors.Innermost(e) {
+			continue
+		}
 		var ce *schema.Error
-		if errors.As(err, &ce) {
+		if errors.As(e, &ce) {
 			filename := ce.Pos.Filename
 			if _, exists := errByFilename[filename]; !exists {
 				errByFilename[filename] = errSet{}