Blair, who celebrates his 52nd birthday today, thus becomes the first Labour leader to have won a third consecutive term in office.
He pledged to respond "sensibly and wisely" to the result, which the BBC predicts will see his majority cut from 167 in 2001 to 66.
Both the Conservatives and the Liberal Democrats gained several target seats on large swings from Labour.
Blair, battered by opposition charges that he lied over the Iraq war, admitted voters had punished his 8-year-old government.
"I know too that Iraq has been a divisive issue in this country but I hope now that we can unite again and look to the future there and here," he said after he won his parliamentary seat in Sedgefield, northern England.
"It seems as if it is clear that the British people wanted the return of a Labour government but with a reduced majority. And we have to respond to that sensibly and wisely and responsibly."
Earlier, exit polls predicted that Labour would win 358 seats in the 646-seat parliament, ahead of the Conservatives with 209. The Liberal Democrats, who opposed the Iraq war, are likely to get 53 seats.
Analysts say the reduced majority is likely to increase pressure on Blair to step down in the middle of his four-year term in favor of his Treasury chief, Gordon Brown, who is seen as the architect of Britain's current economic boom.
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