Northern peatlands are substantial carbon sinks because organic matter in peat is highly stable due to the low rate of decomposition. Waterlogged anaerobic conditions induce accumulation of Sphagnum-derived phenolic compounds that inhibit peat organic matter decomposition, a mechanism referred to as the “enzymic latch”. Recent studies have predicted that the water table in Northern peatlands may become unstable. We observed that such unstable water table levels can impede the development of Sphagnum mosses. In this study, we determined the effects of low and high frequency water table fluctuation regimes on Sphagnum growth and peat organic matter decomposition, by conducting a year-long mesocosm experiment. In addition, we conducted a molecular analysis to examine changes in abundance of fungal community which may play a key role in the decomposition of organic matter in peatlands. We found that rapid water table fluctuation inhibited the growth of Sphagnum due to fungal infection but stimulated decomposition of organic matter that may dramatically destabilize peatland carbon sequestration. Increased pH, induced by the fluctuation, was the primary contributor to the enhanced decomposition of organic matter in peat. The results were independent of species representing different phylogenetical group or habitat (hummocks/hollows). Our study indicates that rapid water table fluctuations can compromise the capacity of peatlands to act as a carbon sink and that maintaining a stable water table is essential for the production of Sphagnum biomass in, for example, Sphagnum farming.