Labour was on course to lose around 200 council seats - around a quarter of the party's councillors who were up for election.
Meanwhile the Conservatives made gains across the country, while the Liberal Democrats beat Labour into third place, according to the BBC's projected national share of the vote.
"I think this is a very big moment for the Conservative Party, but I don't want anyone to think that we would deserve to win an election just on the back of a failing government," party leader David Cameron told reporters outside his London home.
"I think these results are not just a vote against Gordon Brown and his government. I think they are a vote of positive confidence in the Conservative Party."
Theresa May, the Conservative Shadow Leader of the House of Commons, told Reuters: "We had an excellent night...taking far more seats than many of us had thought we might."
She said "crucially" they had made breakthroughs in southern areas where Labour had enjoyed success under Tony Blair and also in the north, gaining control of Bury and winning seats in Labour heartlands such as Sunderland.
"We've made a very good launch for the run-up to the next election."
Government ministers rallied behind Brown, saying the poor results were a consequence of a downturn in the economy which the prime minister would reverse.
Harriet Harman, deputy party leader, told BBC TV: "These are disappointing results and we recognise the difficult economic context, with people feeling the pinch.
"We are determined to listen and are confident to take the country forward."
Stephen Ladyman, a Labour Party vice chairman, said it would be a very different picture by the time of the next general election.
"You are going to really see what his (Brown's) mettle is," he told Sky News.
Brown does not have to call a general election until 2010.
Nick Clegg, the new Liberal Democrat leader, said his party was "gaining momentum".
The Lib Dems gained 11 seats overall, winning control of Kingston-upon-Hull and St Albans but losing Liverpool.
"Everything is up for grabs," Clegg told BBC News.
"It is only the second time in our history in the post-war period that we have overtaken Labour as a share of the vote."
John Curtice, politics professor at Strathclyde University, said the results meant the Conservative Party was "back in business".
"The Conservatives can win the next election. They are not bound to...but the possibility of the Tories winning the next election is now on the cards."
He said Labour's woes had also helped the Liberal Democrats.
"The fact that the Labour party have done so badly is Nick Clegg's salvation," he said.
