diff --git a/bundled/tool/lsp_server.py b/bundled/tool/lsp_server.py
index 6abc0f8..50c6da8 100644
--- a/bundled/tool/lsp_server.py
+++ b/bundled/tool/lsp_server.py
@@ -289,6 +289,23 @@ def on_shutdown(_params: Optional[Any] = None) -> None:
     jsonrpc.shutdown_json_rpc()
 
 
+def get_cwd(settings: dict, document: Optional[workspace.Document]) -> str:
+    """Returns the working directory for running the tool.
+
+    Resolves ``${fileDirname}`` to the directory of the current document.
+    If no document is available, falls back to the workspace root.
+
+    Examples of supported patterns: ``${fileDirname}``, ``${fileDirname}/subdir``.
+    """
+    cwd = settings.get("cwd", settings["workspaceFS"])
+    if "${fileDirname}" in cwd:
+        if document and document.path:
+            cwd = cwd.replace("${fileDirname}", os.path.dirname(document.path))
+        else:
+            cwd = settings["workspaceFS"]
+    return cwd
+
+
 def _get_global_defaults():
     return {
         "path": GLOBAL_SETTINGS.get("path", []),
@@ -393,7 +410,8 @@ def _run_tool_on_document(
     settings = copy.deepcopy(_get_settings_by_document(document))
 
     code_workspace = settings["workspaceFS"]
-    cwd = settings["cwd"]
+    # Pass document so get_cwd can resolve ${fileDirname} to this file's directory.
+    cwd = get_cwd(settings, document)
 
     use_path = False
     use_rpc = False
@@ -498,7 +516,7 @@ def _run_tool(extra_args: Sequence[str]) -> utils.RunResult:
     settings = copy.deepcopy(_get_settings_by_document(None))
 
     code_workspace = settings["workspaceFS"]
-    cwd = settings["workspaceFS"]
+    cwd = get_cwd(settings, None)
 
     use_path = False
     use_rpc = False
diff --git a/package.json b/package.json
index ffd3eea..bed4ceb 100644
--- a/package.json
+++ b/package.json
@@ -64,6 +64,12 @@
     "contributes": {
         "configuration": {
             "properties": {
+                "<pytool-module>.cwd": {
+                    "default": "${workspaceFolder}",
+                    "description": "Sets the working directory for <pytool-module>. Supported variables: `${workspaceFolder}` (workspace root) and `${fileDirname}` (directory of the current file).",
+                    "scope": "resource",
+                    "type": "string"
+                },
                 "<pytool-module>.args": {
                     "default": [],
                     "description": "Arguments passed in. Each argument is a separate item in the array.",
diff --git a/src/common/settings.ts b/src/common/settings.ts
index 0259aff..2e59956 100644
--- a/src/common/settings.ts
+++ b/src/common/settings.ts
@@ -46,6 +46,11 @@ export function getInterpreterFromSetting(namespace: string, scope?: Configurati
     return config.get<string[]>('interpreter');
 }
 
+function getCwd(config: WorkspaceConfiguration, workspace: WorkspaceFolder): string {
+    const cwd = config.get<string>('cwd', '${workspaceFolder}');
+    return resolveVariables([cwd], workspace)[0];
+}
+
 export async function getWorkspaceSettings(
     namespace: string,
     workspace: WorkspaceFolder,
@@ -62,7 +67,7 @@ export async function getWorkspaceSettings(
     }
 
     const workspaceSetting = {
-        cwd: workspace.uri.fsPath,
+        cwd: getCwd(config, workspace),
         workspace: workspace.uri.toString(),
         args: resolveVariables(config.get<string[]>(`args`) ?? [], workspace),
         path: resolveVariables(config.get<string[]>(`path`) ?? [], workspace),
@@ -104,6 +109,7 @@ export async function getGlobalSettings(namespace: string, includeInterpreter?:
 export function checkIfConfigurationChanged(e: ConfigurationChangeEvent, namespace: string): boolean {
     const settings = [
         `${namespace}.args`,
+        `${namespace}.cwd`,
         `${namespace}.path`,
         `${namespace}.interpreter`,
         `${namespace}.importStrategy`,