Political commentators said Brown's party was set to lose about 200 local council seats with its national share of the vote plunging well below the opposition Conservatives, putting it in third place overall.
The results were a damning verdict on Brown's first year in power since taking over from Tony Blair and the poor showing could raise questions about his leadership, analysts said.
But ministers said the poll reflected a downturn in the economy caused by the worldwide credit crunch and Brown would bounce back to win the next national election.
"There's no crisis. This isn't something that's going to affect the fundamental stability of the government," Cabinet minister Geoff Hoon told BBC TV.
Governments in Britain traditionally suffer a bloody nose in mid-term polls, when turnout is often low, and Brown does not have to call a parliamentary election until 2010, by which time he will be hoping the economic picture will have improved.
Some 4,000 seats on 160 councils across England and Wales were up for grabs in Thursday's elections. With 98 councils having reported results, Labour had lost 144 seats while the Conservatives had gained 138.
The BBC projected that the Conservatives' share of the vote was 44 percent with Labour on just 24 percent, pushed into third place behind Britain's third party the Liberal Democrats.
John Curtice, politics professor at Strathclyde University, said the Conservatives had fared better than expected while Labour had done even worse than the most dismal predictions.
He told Reuters the last time a party in government had performed so badly in local polls was in 1995 when the Conservatives polled just 25 percent, two years before they were hammered in national elections by Labour under Blair.
"WORST DRUBBING FOR 40 YEARS"
Newspapers said Brown had been punished by voters angry over his decision to abolish the lowest income tax band.
"Brown takes a local election hammering," the Daily Telegraph said on its website. The Times said Labour had experienced its "worst drubbing in 40 years" while the Guardian said Brown had suffered a "mauling".
The former finance minister had enjoyed a brief honeymoon with voters after he took over from Blair in June.
But the media and opposition accused him of dithering over calling a snap election in October - a move he eventually decided against - and he has also been beset by party in-fighting, economic turmoil and industrial unrest.
"This has been very, very bad for Labour," senior Conservative lawmaker Teresa May told Reuters.
"I think people have been giving the Labour Party a very clear message. They want a change, and the change that this country needs people now recognise is the Conservatives."
Attention will now be fixed on London where two political mavericks are battling for the job of mayor in the closest election since the office was created eight years ago.
Victory for Conservative candidate Boris Johnson in the race to be mayor of London would be a major boost for the party's leader Cameron, who will try to end a Labour run of three successive parliamentary election triumphs.
A win for incumbent Ken Livingstone in the London poll, which will be announced later on Friday, would provide some relief for Brown whose popularity has plunged in recent months along with his reputation for economic management.
"Ken Livingstone stands between Gordon Brown and ... a disaster," Curtice said.
