Labour won the predicted third consecutive general election victory yesterday, but with a greatly reduced majority. It appears to have lost votes largely to the Liberal Democrats, in an unwinding of the tactical anti-Conservative voting of recent elections. The result is a severe blow to Tony Blair's leadership, but offers scant comfort to the Conservatives.

Early indications were pointing to a working majority for a third Labour term, but one well down on 2001. Mr Blair's personal popularity has sunk in the aftermath of the Iraq invasion and the constant focus on the issue at the end of the campaign has taken its toll.

Labour's victory is based on the smallest share of the vote ever won by a party forming a majority government. For this it can thank the Liberal Democrats, whose further progress has turned parts of the electoral map into three-way contests. Mr Blair is the beneficiary of a divided opposition, just as Margaret Thatcher was in the 1980s - but with a declining share of the vote.

The Conservatives seem not to have done much better in number of seats than Labour in 1983, the nadir of its post-war fortunes under Michael Foot. The arrival of new Tory MPs from urban areas will help extend the party's base from the shires and suburbs and broaden its appeal. But Michael Howard's campaign strategy seems to have won little new support.

Mr Howard reflected popular discontents but failed to articulate a coherent vision of a Conservative future that could win back the voters who deserted the party in 1997. That offers no grounds for Tory complacency. Far from suggesting that one more heave will get the party into power, it implies the need for a radical overhaul to create a new consensus that accepts the diversity of modern Britain but favours a smaller state allowing taxpayers to spend more of their own money.

The defeats of 1997 and 2001 were quickly followed by Tory leadership contests that put personnel before policies. This time, it would be better for Mr Howard to stay on while the party thinks about what it needs to do before making a decision about the leadership. For Mr Howard, there could be some personal attractions in staying on, if only to lead the No campaign in next year's planned referendum on the European Union constitutional treaty.

For Labour the loss of so many seats will be disconcerting. Winning the referendum will be no easier after this result, and a No vote would be a fatal blow to Mr Blair's leadership. Meanwhile the party's new weakness is a severe handicap as it faces the challenges of pensions reform and the strained public finances.

A Labour defeat was always improbable short of an economic crisis or a collapse of confidence in the government. But the outcome of the election means that Labour will find its third term parliament a less docile body. The likelihood is that Mr Blair will face pressure to hand over to Gordon Brown sooner rather than later.