Tony Blair is heading for an historic third term in government but with a greatly reduced majority.
Mr Blair pledged to respond "sensibly and wisely" to the result, which the BBC predicts will see his majority cut from 167 in 2001 to 66.
The Conservatives have gained several target seats on large swings from Labour, mostly in the South East.
The Lib Dems have also made big inroads on Labour majorities and won 10 seats so far from Labour.
Speaking as he was returned on an increased majority in Sedgefield, Mr Blair said it was clear that "the British people wanted to return a Labour government but with a reduced majority".
He said Labour had to "focus on the things that matter" such as the NHS, jobs and law and order.
He added: "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."
Chancellor Gordon Brown said the party would "listen and learn", a reflection according to the BBC's Political Editor Andrew Marr, of his disappointment with the party's performance so far.
Sunderland South was the first seat to declare, with a win for Labour's Chris Mullin, in what the returning officer is claiming was a record time.
There has been a 5% swing to the Conservatives in London, where the party has unseated schools minister Stephen Twigg, who famously snatched the seat from Tory Michael Portillo in 1997.
The Tories have also gained Shipley from Labour, unseating junior minister Christopher Leslie, and taken Newbury from the Lib Dems.
Tories unseat Labour minister Stephen Twigg
Anti-war candidate Reg Keys polls 10% in Sedgefield
Alan Milburn quits frontline politics
Lib Dems unseat Labour's Barbara Roche on a 14% swing
Lib Dems fail to unseat top Tories
BNP gains 5% of vote in seats where it stood
Robert Kilroy-Silk polls just 2,957 votes
Turnout up slightly on 2001
The Lib Dems held on to Cheadle, which had been the Conservatives' top target, and unseated Labour ex-minister Barbara Roche on a 14% swing.
But they failed in their "decapitation" strategy to unseat ex-Tory chairman Theresa May and shadow home secretary David Davies, who both retained their seats with increased majorities.
BNP leader Nick Griffin took 9% of the vote in Keighley, where Labour's Anne Cryer was returned as the town's MP.
Former Conservative minister Sir Malcolm Rifkind said his party was increasing its share of the vote, "but not as dramatically as we would like".
"We are smiling and the Labour Party is looking pretty glum," he added.
Labour election coordinator Alan Milburn, who quit as health secretary in the last Parliament, said after his re-election that he had told Mr Blair he did not want to serve in the new Cabinet.
The result in Bethnal Green and Bow, scene of a bitter battle between anti-war Respect leader George Galloway and Labour's Oona King, who voted for the Iraq war, is due shortly.
Reports from the count suggest that the result is very close.
Conservative leader Michael Howard saw off the Lib Dem challenge in Folkestone and Hythe, almost doubling his majority.