At his monthly press conference, Blair said that Britain should join countries like France and Germany in holding a "sensitive" discussion on multi-cultural relations.
But he also signalled that Islam should examine how it "comes to terms with" the modern world, indicating that this was "ultimately where the answer to this will be found".
On the veil, he told reporters: "It is a mark of separation and that's why it makes other people from outside the community feel uncomfortable.
"No-one wants to say that people don't have the right to do it. That's to take it too far.
"But I think we do need to confront this issue about how we integrate people properly with our society."
Blair had previously steered clear of the veils row, which flared up two weeks ago when cabinet minister Jack Straw, a former foreign minister, said he asks Muslim women at his constituency office to remove them.
He later added that he would prefer if women did not wear veils at all, provoking a furious response from some Muslim groups.
Blair said he backed the local authority's handling of the Azmi case, adding: "I can see the reasons why they came to the decision that they did."
Asked if the veil was a barrier to integration, Blair told reporters: "In certain circumstances, it can make it very, very difficult but I think it's part of a broader question."
"People want to know the Muslim community in particular, but actually all the minority communities, have got the balance right between integration and multiculturalism," he added.
"We need to conduct this debate in a sensitive way but it needs to be conducted."
A similar debate is going on in most major European countries, including Germany and France, as well as in Malaysia, Indonesia and Singapore, Blair said.

Copyright AFP (Agence France-Presse), 2006