Results from 151 out of the 176 local authorities in England taking part in the polls showed that Labour had suffered a net lost of 234 council seats.
In contrast, the main opposition Conservatives gained 247 seats, giving a big boost to new leader David Cameron in the first real test of his leadership.
The smaller opposition Liberal Democrats, also with a new leader, had a poor showing, with a net gain of three seats, while the right-wing British National Party did relatively well, capturing at least 13.
The final outcome is due later on Friday.
The prime minister is reshuffling his cabinet in a bid to regain momentum after days of bad headlines.
But a member of Mr Blair's party dismissed the shake-up as merely "rearranging the deckchairs on the Titanic", with the prime minister under growing pressure to announce a date for his own departure from office.
Labour is reeling from two of its darkest weeks since taking office nine years ago, following a raft of problems including a sex scandal, a foreign prisoner row and financial sleaze allegations.
The bad news has taken its toll, with a growing number of voters shunning Mr Blair's party for the Conservatives.
It took a particularly bad hammering in London, where control of all 32 local authorities is being contested.
The casualties include Hammersmith and Fulham in west London, which returned to Conservative control from Labour for the first time since 1968.
Labour has so far lost overall control of 16 councils, including Stoke-on-Trent in Staffordshire and Bury in Greater Manchester, and Lewisham, Merton and Camden in London. It has gained Lambeth.
The Conservatives have gained Crawley, Ealing and Bexley from Labour along with the London councils, as well as winning Hillingdon and Harrow.
Among the smaller parties, the Greens have won 17 seats, with particular success in Norwich. The UK Independence Party has won a seat in Hartlepool.
Scandals
Trying to put a brave face on the bad numbers, Culture Secretary Tessa Jowell blamed her party's recent scandals: Deputy Prime Minister John Prescott admitting to an affair with his secretary and Home Secretary Charles Clarke making mistakes in the failed deportation of foreign convicts.
"I don't think that we are going to do as well as we might have hoped to two weeks ago," Ms Jowell told the BBC.
Frank Dobson, a former Labour health secretary, likened the cabinet reshuffle to "rearranging the deckchairs on the Titanic, or in this case changing the ship's officers on the Titanic."
"I don't think it will be good enough, quite frankly. We need the party under new management," he said.
A BBC survey revealed on Friday that half of Britain's voters want Mr Blair to quit by the end of the year as they increasingly see him as arrogant, untrustworthy and wrong to support the Iraq war.
Mr Blair, serving his third straight term, has pledged to stand down ahead of the next general election, due by May 2010 at the latest, with his finance minister, Gordon Brown, seen as his virtually undisputed heir apparent.
The latest local election is not a reflection of the whole of Britain as Wales, Scotland and Northern Ireland did not take part, but the loss of confidence across England will be sorely felt by Labour.