The 21-year-old ended last season on loan with Derby, scoring twice in 16 appearances.
Palmer, helped Huddersfield Town gain promotion to the Premier League in a previous temporary switch, and last season was part of the Derby County side that reached the Championship play-offs.
The Lewisham native is yet to make a senior appearance for Chelsea, having moved to Stamford Bridge while still a trainee from fellow London club Charlton Athletic.
Palmer told Blackburn’s official website: “I’m happy to be here and want to be a part of something exciting.
“Moving forward I want to achieve something special here.
“As soon as I spoke to the manager and heard what he wanted to do here, the way he likes to play and having watched a couple of games last season, I felt it is a club heading in the right direction.”
The midfielder will wear the No 45 shirt at Ewood Park.
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