Asylum seekers are held for seven days at Oakington
The Court of Appeal decision on Friday comes after a High Court judge last month said four asylum seekers were unlawfully detained there while their application to stay in the UK was considered.
He said: "This rational and understandable judgement reinforces confidence in our judiciary and legal system.
"Oakington is an important element in the effective operation of tough but fair immigration controls."
Failure to win the appeal could have forced the government to release all the asylum seekers at the £4.5m centre, designed to cut the backlog of more than 100,000 undecided asylum applications.
That could have paved the way for the government having to pay out millions of pounds of compensation.
Although the four Iraqi Kurds who brought the case have been given leave to appeal to the House of Lords.
Detention restrictions
The judges sitting in the Court of Appeal - Lord Phillips, Lord Justice Schiemann and Lord Justice Waller - suggested Mr Blunkett had already exceeded the requirements of the European court by deciding not to detain asylum seekers much beyond a week.
Lord Phillips said: "The vast majority of those seeking asylum are aliens who are not in a position to make good their entitlement to be treated as refugees.
"We believe, nonetheless, that most right thinking people would find it objectionable that such persons should be detained for a period of any significant length of time while their applications are considered, unless there is a risk of their absconding or committing other misbehaviour."
The judge said restrictions of detaining foreigners came from the UK's historical recognition of the importance of liberty, rather than from the European convention.
But the loss of freedom in the Iraqis' case fell "at the bottom end" of interference with that right, he said.
Lord Phillips said: "It is right, nonetheless that its legitimacy should have received strict scrutiny. Our conclusion is that it is lawful."
'Deeply disturbed'
Last month Mr Blunkett said he was "deeply disturbed" at the landmark ruling that held that the men had had their human rights breached.
Asylum seekers are held at the centre, which opened in March last year, for seven days while waiting for initial decisions on their applications.
Mr Justice Collins ruled that the four men had not been lawfully detained as they were neither likely to abscond nor in the process of being deported.
He held that to impose detention just to speed up the determination of claims breached human rights laws.
'Tough but fair'
Attorney General Lord Goldsmith QC, argued at the Court of Appeal earlier this month that human rights legislation did not affect the Government's attempt to operate "tough but fair" immigration controls.
He told the appeal judges Master of the Rolls Lord Phillips and Lords Justices Schiemann and Waller that if detention was limited to those who may abscond, it would be "a serious matter of concern".
He said since Oakington opened, of the 7,747 applications decided 7,690 were refused.
The four Iraqi Kurds involved are Dr Shayan Saadi, who arrived at Heathrow airport in December 2000 and immediately claimed asylum; Zhenar Maged, Dilshad Osman and Rizgan Mohammed all arrived at Dover in the same month in the backs of lorries.
Three of the men have since been granted refugee status on appeal. Two benefited from a technicality.