The opposition Conservatives and the Liberal Democrats are lagging far behind, with just 108 and 38 seats respectively. Smaller parties or independents won 11 seats.
Blair, who turns 52 on Friday, said he expected to win a third straight term in power but admitted the British public wanted to clip his wings.
"If, and I say if, the predictions are right, it looks like the Labour Party is heading for the first time in its history for a historic third term," he said after winning his home constituency of Sedgefield, northern England.
"It seems clear ... that also the British people wanted the return of a Labour government but with a reduced majority," he conceded.
A television exit poll earlier predicted a historic win for Blair in Thursday's election, but with a vastly reduced mandate for his party.
The exit poll, for main television broadcasters the BBC and ITV, said Blair would have a majority of only 66 seats in the 646-seat parliament, down from 161 gained in the last election.
The reduced majority could curb Blair's authority in his third term, when he is expected to try and persuade Eurosceptic Britons to approve the EU constitution and will probably oversee the withdrawal of 8000 troops from Iraq.
"It seems clear ... that also the British people wanted the
return of a Labour government but with a reduced majority"
British Prime Minister Tony Blair
If the exit poll predictions come true, Blair would become only the second prime minister in British history after Margaret Thatcher to win three elections in a row.
He will also become the first prime minister to win three
consecutive terms for Labour, the once-socialist party founded in 1900 and now the dominant force of the British centre-left.
"If the exit poll holds true this is incredibly bad news for Blair," said Mark Wickham-Jones, senior lecturer in politics at Bristol University. "The result is much better than the Conservatives thought they were going to get.
"There is a sense in which this election has been a referendum on Blair and I think it is going to leave him considerably weakened," he said. "My guess is it really hastens Blair's departure... He may not be there at Christmas."
Britons - 44 million of them eligible - voted in 645 constituencies across England, Scotland, Wales and Northern Ireland earlier on Thursday in general elections marked by widespread bitterness over the war in Iraq.
Shortly after polls opened on Thursday, a building housing the British consulate and other offices in New York was slightly damaged by what police said were two small "novelty grenades".
Blair has been prime minister
since a landslide victory in 1997
No one was injured, and there was nothing immediately to suggest the blast targeted the consulate or was linked to the elections.
Still, journalists witnessed an increased police presence in London after warnings by police of possible attacks in the run-up to the vote.
A smiling Blair, accompanied by his wife Cherie and sons Euan and Nicky who were voting for the first time, cast their ballots in his northern English constituency of Sedgefield, where he later saw off challenges by several candidates, including an independent who lost a son in the Iraq war.
Blair's Labour won landslide victories in 1997 and 2001, but his popularity has eroded since he sent troops in support of the US-led invasion of Iraq in March 2003.
The conflict, and especially Blair's rationale for joining it, has haunted the premier throughout a difficult election fight during which Howard openly labelled him a liar.
Blair repeatedly warned that if too many disgruntled Labour voters, or even those just confident of a Labour win, stayed at home, it could bring a "backdoor" win for the Conservatives.
Analysts dismiss this as extremely unlikely, but also note that the turnout could easily fall below the 59.4% seen in 2001, the lowest figure since the first world war.
At a polling station in Hammersmith-Fulham, probably the tightest race in London, Jane Wess, 30, cast her vote.
Blair's decision to invade Iraq will
cost him votes, say experts
"I voted LibDems, because I'm very much against the war in Iraq and against [university] tuition fees," she said. "I used to vote Labour but before Blair - I don't like him. There's not much difference between Labour and LibDem anyway."
Blair's likely return to office would be partly because of the continued weakness of the Conservatives, now on their fourth leader since losing office in 1997.
Labour held a 161-seat majority, with 410 seats, in the last 659-seat House of Commons against 162 for the Conservatives and 54 for the Liberal Democrats.
Following revisions to the electoral map, the new parliament will have 646 seats.
"There is a lot there at stake for Blair," warned political analyst Philip Cowley, saying anything below a 60-seat majority would be bad for him.
Anything below 40, however, "I think he would have to go very soon".