Aqueous solutions of hydroxypropylcellulose (HPC) have been widely used as a model system to study liquid crystalline behavior in polymers. The HPC limiting concentration for mesophase formation in water is about 40% wt, quite independent of molecular weight. Most rheo-optical investigations have been carried out in the concentration range from 50% to 65% wt, on the assumption that only the liquid crystalline phase was present. In this study, by using video-enhanced contrast light microscopy, we show that an isotropic phase in form of tiny droplets is also present at concentrations up to 60% wt, both in quiescent and in sheared samples at room temperature. The isotropic phase can be made to disappear by lowering the temperature. The effects of phase separation on the theology of the HPC/water system are studied by measuring viscosity as a function of temperature and concentration. A slope of Region I of the viscosity curve close to -0.5 is found only at low temperatures, when the sample is fully anisotropic, whereas an anomalous dependence of the viscosity on temperature is observed when phase separation is significant. This study shows that special care is needed when interpreting experimental results from the HPC/water system in terms of theories for liquid crystalline polymers.