England are staring down the barrel of a first World Cup group exit since 1958 after Luis Suarez's brace secured Uruguay a hard-fought victory.
Wayne Rooney thought he had snatched a draw for England after he equalised Suarez's opener in the first half.
But with five minutes left on the clock Steven Gerrard accidentally put the controversial Liverpool striker through and he beat Joe Hart to give the Uruguayans a 2-1 win.
Adam Lallana and Rickie Lambert both got on the pitch as second half subs.
Only a minor miracle will keep England in the tournament now.
If Costa Rica and Italy draw on Friday afternoon, or the Central Americans beat Cesare Prandelli's team, England will be eliminated with one match to spare.
If Italy won both their remaining games, Uruguay, Costa Rica and England will be tied for second spot, provided that Hodgson's men win their final match.
That seems unlikely after the defensive performance shown here on Thursday night.
No team in World Cup history has gone through after two defeats, so England might as well start thinking about going home after next Tuesday's game in Belo Horizonte against Costa Rica.
England showed promise in their first match against Italy, but in Sao Paulo they came up against a rigid and bruising Uruguay defence.
They had their chances to take something from the game. Rooney hit the bar and went close with a brilliant free-kick in the first half.
But once again, the attack cannot be blamed for the result.
England's defence was poor. They always looked susceptible to pace and Suarez, despite being half-fit, caused them problems all night.
Suarez played up to the role of the role of pantomime villain from the beginning of the evening, winking at his Liverpool team-mate Gerrard in the tunnel.
His first touch was greeted by loud boos from the 8,000 England fans sporting red and white in the far corner of the stadium.
Those supporters were made to endure a nerve-jangling opening 10 minutes as England started on the back foot.
Suarez's cross deflected off Gary Cahill's head and Hart almost spilled the ball into his own net, before the England goalkeeper nervously palmed away a Suarez corner.
It was not the start England wanted.
The pressure lifted for a moment when Diego Godin was booked for punching Daniel Sturridge's through-ball.
Rooney steadied himself and bent the resulting free-kick over the wall and narrowly wide of Fernando Muslera's goal.
Uruguay soon had England rattled again.
Phil Jagielka made a real hash of his clearance and the ball fell to Cristian Rodriguez, who belted a left-foot drive that flew an inch over.
Gary Cahill soon followed suit, making another poor clearance, but once again Uruguay could not capitalise.
A concerned Hodgson came to the edge of his technical area to bark orders to his players. It had little effect though as Uruguay continued piling on the pressure.
Cahill had to put in a last-ditch tackle to deny Edinson Cavani and the Paris St Germain man then clipped a shot just over the bar.
Godin was lucky to stay on the pitch when his outstretched arm hit Sturridge in the neck.
Then came Rooney's big chance of the first half. The striker connected with Gerrard's free-kick just under the goal frame, but his header struck the frame and bounced out.
Then, seven minutes before the break, Suarez struck.
Gerrard lost the ball on the halfway line while England had men upfield and Uruguay hit on the counter. Glen Johnson gave Cavani enough time and space to curl a peach of a cross that looped over Cahill's head and Suarez did the rest.
The Liverpool striker wheeled away before being mobbed by his team-mates.
England's defence again switched off after the break, allowing Cavani through, but luckily for the Three Lions, he shot wide.
Rooney found space in the box at the other end of the pitch, but he could only fire at Muslera. It was as if he was destined to never score a World Cup goal.
Gerrard's emotions got the better of him as he clattered into Rodriguez to earn a booking.
Hodgson brought on Ross Barkley, who immediately injected some life into the England midfield.
Sturridge, Johnson and Barkley all entered the box, but nothing was working for England - until Johnson went on a run down the right flank.
Johnson, who had been poor all night, took one player on and slipped the ball through the legs of Alvaro Gonzalez to Rooney, who prodded home.
Hodgson leapt up in celebration and Rooney looked to the skies. Finally the monkey was off the Manchester United striker's back. Finally England could breathe again.
England went for the kill. Sturridge broke into the box and was knocked to the floor by Alvaro Pereira, but the referee waved play on.
But with five minutes left Suarez struck the killer blow.
Gerrard mistakenly flicked on a long punt and Suarez drove a low ball past Hart.
England threw everything they had at Uruguay - Hart even came up for a corner - but nothing worked and Suarez was held aloft by his jubilant team-mates at the final whistle.