We introduce the Virgo Consortiums EAGLE project, a suite of hydrodynamical simulations that follow the formation of galaxies and black holes in representative volumes. We discuss the limitations of such simulations in light of their finite resolution and poorly constrained subgrid physics, and how these affect their predictive power. One major improvement is our treatment of feedback from massive stars and AGN in which thermal energy is injected into the gas without the need to turn off cooling or hydrodynamical forces, allowing winds to develop without predetermined speed or mass loading factors. Because the feedback efficiencies cannot be predicted from first principles, we calibrate them to the z~0 galaxy stellar mass function and the amplitude of the galaxy-central black hole mass relation, also taking galaxy sizes into account. The observed galaxy mass function is reproduced to $lesssim 0.2$ dex over the full mass range, $10^8 < M_*/M_odot lesssim 10^{11}$, a level of agreement close to that attained by semi-analytic models, and unprecedented for hydrodynamical simulations. We compare our results to a representative set of low-redshift observables not considered in the calibration, and find good agreement with the observed galaxy specific star formation rates, passive fractions, Tully-Fisher relation, total stellar luminosities of galaxy clusters, and column density distributions of intergalactic CIV and OVI. While the mass-metallicity relations for gas and stars are consistent with observations for $M_* gtrsim 10^9 M_odot$, they are insufficiently steep at lower masses. The gas fractions and temperatures are too high for clusters of galaxies, but for groups these discrepancies can be resolved by adopting a higher heating temperature in the subgrid prescription for AGN feedback. EAGLE constitutes a valuable new resource for studies of galaxy formation.
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