The Conservative campaign is resonating with the public and the government must adapt in order to survive, a senior Cabinet minister has warned.
Gordon Brown's fortunes have varied in 2007
The admission by Justice Secretary Jack Straw comes as Gordon Brown used his New Year message to say 2008 will see "real and serious changes" in the UK.
The government would see through reforms in "vital areas" such as energy, pensions and health, he said.
In his message, Tory leader David Cameron pledged to set the 2008 agenda.
Mr Straw, who is also Lord Chancellor and one of Mr Brown's closest cabinet colleagues, told the Sunday Times the prime minister had faced difficulties in recent months that must be put right.
And in a rare admission by a senior minister, he acknowledged Mr Cameron may have benefited from the government's recent woes and that his messages appear to be "resonating" with voters.
Ministers have previously sought to dismiss the Tory leader as lacking in substance.
Mr Straw, who ran the prime minister's leadership campaign, said the key for Labour was showing the public that it was making "decisions that are relevant to their futures and not just resting on our laurels".
"All periods are crucial in government - and up to two-and-a-half years before the next election, which is a long time - but for sure we have got to make clear progress in the next year and everybody understands that," he added.
Shadow Work and Pensions Secretary Chris Grayling said Jack Straw's admission showed David Cameron's ideas were appealing to voters.
But he said: "We're nowhere near being on the point of taking over government.
"We have a lot of work to do to continue to earn people's interest, their trust and their confidence that we're putting forward the right ideas for Britain."
Since taking over as prime minister in June, Mr Brown's fortunes have fluctuated.
He enjoyed initial success in the opinion polls after dealing with a number of high-profile issues, ranging from a foot-and-mouth outbreak to an attempted terror attack. But his popularity has faltered in recent months.
He was widely criticised for appearing indecisive about calling a general election and his government has been hit in recent months by revelations of alleged impropriety in Labour party funding, as well as the loss of discs containing the personal details of 25 million people.
But in his first New Year message since becoming PM, Mr Brown strikes a confident note, insisting 2008 will see "measurable changes in public services".
It was also the year for "stepping up major long-term reform to meet challenges ranging from globalisation and global warming to the great unfinished business of social reform in our country," he said.
Mr Brown said tackling the global credit problem was an "immediate priority" and underlined the continuing terrorist threat.
"We will not shirk but see through changes and reforms in the vital areas for our future - secure energy, pensions, transport, welfare, education, health and national security," he added.
Meanwhile, Mr Cameron committed himself to working as if there would be a general election in 2008, even though he believed there would not.
He said his party now offered a "clear and credible alternative" to what he described as a "hopeless and incompetent Labour government".
"I want 2008 to be the year in which we offer the people of this country the hope of real change, by setting out a clear and inspiring vision of what Britain will look like with a Conservative government," he said.
The Tories would offer safer communities through police reform and more prison places, as well as "the hope of a decent education for every child" with radical reforms of the school system, he said.