Jack Straw, the foreign minister, and Charles Clarke, the home secretary, lost their jobs as did John Prescott, who is Blair's deputy prime minister. He had recently been in the news because of an extramarital affair.
Margaret Beckett, the environment minister, takes over from Straw.
The cabinet reshuffle comes after accusations of government incompetence and sleaze over the past few weeks as well as the poor local election results, which have put pressure on Blair to give his government new impetus or step aside.
Ben Page, a pollster for Mori, said: "This is clearly a major reshuffle. It looks as though he is going for a radical change."
Clarke will leave government and Straw becomes leader of the lower house of parliament. John Reid, the defence minister, will take over from Clarke, who has been accused of incompetence after foreign prisoners were released without checks when they should have been deported.
By-elections were held on Thursday in 176 of the 388 local authorities in England, with 4,360 council seats up for grabs.
According to the BBC, Labour had lost 256 of the 1,768 seats it was defending, while a resurgent opposition Conservative party under David Cameron, its new leader, gained 252.
Gordon Brown, the finance minister, said before the reshuffle: "This is a warning shot for us as a government. The renewal of the Labour Party must start now."
Punishing the government
Brown, who has been finance minister ever since Labour returned to power in 1997, is expected to take over from Blair before the next general election, due by mid-2010 at the latest.
Blair, who won his third straight election in 2005, has said he will quit before the next election, but has not set a date.
Brown said: "We have got to show in the next few days, not just the next few weeks, that we have sorted these problems out. I will be talking to Tony Blair about these issues over the weekend."
Voters in Britain traditionally use local elections to punish the government, but analysts had said the loss of many more than 200 seats would be seen as a bad result for Blair.