A long, uncertain process to form a coalition government now seems likely amid concerns the center-right opposition may reach out to the Sweden Democrats, a party with roots in the neo-Nazi movement, to take power.
Prime Minister Stefan Lofven's ruling center-left bloc maintained a slight lead with 40.6% of the vote, with the center-right alliance winning 40.3%.
However, the unaligned far-right Sweden Democrats gained 17.6% of the vote, up from 12.9% in the previous 2014 elections.
Results were based on 99% of the vote confirmed and will not be finalized until Wednesday when overseas votes are counted.
Claiming a kingmaker role for this party, Jimmie Åkesson, leader of the Sweden Democrats, said in a speech at his campaign headquarters that his party will now have "influence over Swedish politics."
Lofven's governing center-left Social Democrats won the largest share with 28.4% of votes cast, while the center-right Moderates took 19.8%. Both parties are joined by a number of smaller fringe parties in forming their respective coalition blocs.
At a rally after the polls had closed, Lofven said he would remain in office in the coming weeks and called for cooperation across the political divide.
"We have two weeks left until parliament opens. I will work on calmly, as prime minister, respecting voters and the Swedish electoral system," Lofven told a party rally.
"We wanted to see a better result, there's no doubt about that. But despite this, the voters have made the Social Democrats the biggest party," he said to cheers from supporters.
Even though both main blocs have pledged not to work with the Sweden Democrats, its increased support has fueled fears that the rise of the far-right across Europe has now reached Sweden, one of the world's most liberal countries.
Sweden was once particularly welcoming to refugees, but the issue of migration has became highly politicized following a steady increase in new arrivals. In 2015, Sweden, a country of 10.1 million people, took in more than 160,000 asylum-seekers.
Support for the far right in Sweden mirrors similar trends in other European nations following the mass migration of refugees to the region in 2015, at the height of the Syrian war. Anti-migrant parties in Germany, Austria, Denmark, France, Hungary, Italy and the UK have all made gains in recent years.
The Sweden Democrats want to freeze migration and have pushed for the country to leave the European Union.
However, the party's results did not meet expectations ratcheted up by exit polls predicting it would become Sweden's second-biggest party.
The results show Sunday's vote was one of the toughest challenges in decades to Sweden's social democracy, characterized by its high tax rates and substantial welfare system, aimed at reducing inequality through social inclusion.
Migration a game-changer
Senior Social Democrats official Anders Ygeman conceded that the crisis had damaged his coalition's prospects.
"We paid the price for being in government. We suffered from the refugee crisis in 2015. That's why the Sweden Democrats are as big as they seem to be," he told CNN in Stockholm.
Voter Anton Loin said Swedes were increasingly looking for political alternatives. "I think that it shows that people are disappointed with how the country is run, and they are rooting for something, they want something different, but it's not necessarily the best kind of different," he said of the far right's rise.
Tuva Sundh, who also cast her vote Sunday, said she was concerned about integration. "But I'm not sure about the way of the Sweden Democrats. I think it's healthy to have debate. But I do think it's become too heated in this election."
Leaders in Brussels will be disappointed with the party's surge ahead of the European Parliament's elections in May next year, as they bid to discourage euroskepticism following the UK's decision to leave the EU, and as populist parties form alliances to shake up the EU establishment ahead of the vote.
Far-right populists in Europe, however, were celebrating the Sweden Democrats' rise.
Marine Le Pen, leader of France's far-right euroskeptic National Rally, said on Twitter: "Another bad night for the European Union in perspective. The democratic revolution in Europe is underway!"
The Social Democrats and its allies have tried to appease anti-migrant sentiment in the country by urging more integration programs and resources for refugees in marginalized communities, and to help them access education.
The center-right Moderates had pledged to give more funds to the police, and pushed for Swedish migration policy to fall in line with laws in other EU countries, such as Denmark and Germany. This would mean that migrants won't be able to stay unless they can prove that they can support themselves, enabling them to get a permanent residence permit.
They were also looking at ways of more quickly incorporating migrants into the workforce, such as promoting "simple jobs," a reference to work that can be obtained with only an elementary education.
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