Raonic, from Thornhill, Ont., could not duplicate his upset win of just over a week ago against Roger Federer as he lost his opening match to the Swiss star 6-1, 7-6 (0).
Raonic denied that he might have been spooked by the unrelenting and overwhelming crowd support for his iconic Swiss opponent and the pressure of the big moment. He said he was simply outplayed by the man he beat nine days ago in a Paris quarter-final, his first win over Federer in seven meetings.
"It's obviously disappointing, very disappointing actually, the way I finished that second set off," said Raonic, who plays Tuesday against Andy Murray.
"It took me more a set to find my way into the match because of playing Roger, not because of being here for the first time.
"Every time you play Roger, the crowd's on his side, even if he's playing a local favourite. It's hard for people to cheer against Roger."
Federer, a 17-time Grand Slam champion chasing a seventh title at the year-end tournament, saved all four break points he faced to avenge his loss to the big-serving Raonic in Paris.
"Thankfully he didn't play quite so well, like he did in Paris maybe," the second-seeded Federer said. "He gave me a few shots here and there, especially at the beginning of the breaker. I think those were crucial. I was happy to bring it home because it was very close at the end of the second."
Earlier, Japan's Kei Nishikori beat home favourite Murray 6-4, 6-4, and in doubles action Toronto's Daniel Nestor and partner Nenad Zimonjic lost their first match 6-3, 7-5 to Croatia's Ivan Dodig and Brazil's Marcelo Melo.
Raonic went down to Federer in just under 90 minutes.
Federer dominated the first set, then had to fight off Raonic as he saved a set point in the second set before wrapping up the win with a love tiebreak.
Raonic, who finished with 10 aces, took his total for 2014 past the 1,100 mark. Raonic remains one victory short of his 50th win of the season.
He ended with 20 winners, 17 unforced errors and went 0-4 on break point chances.
"There is always the difficulty of a different atmosphere, different everything in the first round," said Raonic, who served as a London alternate in 2013 but never got onto court.
"You have to play against one of the best players of all time in that situation. That was the biggest difference, trying to demand a high level right from the get-go.
"But other than that, it really didn't feel too different than other situations I've been in."
Raonic said it was a different Federer on Sunday than the one he upset in Paris.
"He was a lot more consistent on his return games," Raonic said. "In Paris, I'd get free points when I hit aces, but today, when he got his racquet on the ball, he would make me play all the time.
"I believe he played better today. I believe I started off not playing nearly as well, but I think I sort of found that Paris level in the second set. That's why I was able to create some opportunities for myself."
Meanwhile, Murray is now facing an uphill task to reach the elite tournament's semifinals.
The fourth-seeded Nishikori — the first Asian player to qualify for the year-end championship — was in complete control and secured important points in a tough Group B that also includes Federer and Raonic.
After the round-robin stage, the top two finishers in each group advance to the semifinals of the indoor tournament at the O2.
"Obviously now I need to win my next two matches more than likely, and win them well if I want to go through," said Murray, who missed last year's tournament after undergoing surgery on his back. "That's going to be tricky because Milos obviously played fantastic last week in Paris, and Roger always plays well at this event. So I'm definitely going to have to play better if I want to get through."
Murray, who had never lost a set to Nishikori in their three previous matches, only sealed his spot at the season finale last week in Paris following an impressive run that saw him win 20 of his previous 23 matches.
But the former Wimbledon champion never looked capable of turning the match around. He dismissed the idea that fatigue finally took its toll on him.
"I felt OK on the court today," he said. "I don't think that was the reason why I lost the match."
Murray, who had expressed worries that he could be rejected by local fans after coming out in favour of Scottish independence in September, received a warm welcome as he entered the court.
The Scot secured the first break in the fifth game after taking advantage of his opponent's unforced errors but could not hold his next serve after hitting two double-faults.
Nishikori did not serve well either, hitting eight double-faults and averaging a low first-serve percentage of 46. But Murray's struggles were even worse, winning only seven points on his second serve.
"I didn't serve well enough. He was able to dictate a lot of points, especially behind my second serve," said Murray. "That was the difference."
After a cautious start, Nishikori pushed Murray into long rallies before overwhelming him with powerful groundstrokes. Pegged back well behind his baseline, Murray saved one set point with a crosscourt forehand that Nishikori could not return but fluffed a backhand drop shot on the next one.
The Japanese player continued at the same pace in the second set and broke for a 2-0 lead after leaving Murray stranded on the baseline with a fine drop shot. The two-time Grand Slam winner fought hard to save three break points in the fourth game to stay in the match and a series of errors from Nishikori in the seventh game helped him to break back.
Murray levelled at 4-4 but could not build on the momentum as Nishikori converted his first match point in the 10th game when Murray dropped his serve for the fourth time following three consecutive backhand errors.
"The second set was almost perfect," said Nishikori. "I knew he is very consistent from the baseline so I knew I had to be more aggressive than usual and that's how I won today."
Nestor, playing his last event with longtime partner Zimonjic, sealed his side's fate as he double-faulted to put his team into a 5-6 hole in the second set.
The second seeds could not recover, with Dodig and Melo winning a game later on the first of three match points.
"We had too many mistakes, too many double-faults," Nestor said. "We gave them some points, they played well, but we shot ourselves in the foot today.
"I'm trying to win, no matter who I play with, obviously it would be nice to win our last tournament together."
Nestor and Zimonjic, who won the year-end title in 2008 and 2010, finished with seven aces but were able to convert on only one of four break point chances against Dodig and Melo.
The pair have split up for 2015, with Nestor teaming with Indian Rohan Bopanna.
— With files from The Associated Press