Knopfler grew up in Newcastle upon Tyne, England, where he attended Gosforth Grammar School. By age 11, he owned a guitar, a piano and a drum kit, and by age 14, he was performing his own songs in folk clubs. After attending Bristol Polytechnic, he became a social worker in London, where he shared a flat with John Illsley.

Knopfler introduced Illsley to his older brother Mark, and they (together with drummer Pick Withers) became the founders of Dire Straits. A friend of Mark Knopfler's assisted in deciding the name, a reference to their financial situation. Knopfler, however, asserts at his website that "the notion that the band were literally in dire straits is largely retrospective myth making and not really factually supportable. We all had day jobs until we got a whacking big advance from Polygram".

Knopfler played rhythm guitar behind his brother on lead guitar, and appeared on Dire Straits' first two albums (1978's Dire Straits and 1979's Communiqué). He recorded their third album, Making Movies, with the band before leaving to become a solo artist, and was left uncredited on the album.

After leaving Dire Straits, Knopfler released his first solo album in 1983, titled Release. Mark Knopfler and John Illsley both guested on the album. Harry Bogdanovs, a lifelong friend of Knopfler, is credited with playing synthesizer. The album was suported by the single "Soul Kissing", on the ill-fated label, Peach River Records. The single was a minor commercial success after Knopfler retrieved the rights from the bankrupt record label. Behind the Lines, his second album, was released in 1985 and his third solo album, Cut the Wire, followed in 1986. In 1988, the U.S. label Cypress Records released his fourth album, Lips Against the Steel.

Knopfler scored the soundtracks for the films Shergar (1984) and Laser Mission (1990), and the German productions Treffer (1984), Jakob hinter der blauen Tür (1989) and Der grosse Bellheim.

Lifelines in 1991 released by Phonogram, was recorded in Peter Gabriel's Real World Studios. The album was followed in 1993 by The Giver, released by MESA/Bluemoon in the U.S., and Ariola in Europe. Its sparse, acoustic arrangements received positive reviews, as did 1995's Small Mercies, which Knopfler co-produced with Harry Bogdanovs, featuring Chris White on saxophone. In 2001 Knopfler worked with Bogdanovs again to co-produce the album Wishbones, which has a guest appearance by Chris Rea.

His ninth solo album, Ship of Dreams, which also included Chris Rea, was released in 2004. In May 2005, he published a book of poetry titled Blood Stones and Rhythmic Beasts, which was released by the UK's BlackWing books (ISBN 0955026008).

The U.S./Canadian jazz label Justin Time Records released Ship of Dreams in October 2005 with an alternate rendition of "Tears Fall" featuring Megan Slankard (replacing Julia Neigel on the original European release).

Knopfler's tenth solo album Songs for the Siren was released in 2006.

Recent song writing projects with other songwriters have included sessions with Amilia Spicer, Mack Starks, Megan Slankard and Wendy Lands.

In Autumn 2006 he appeared on stage dueting with Karine Polwart at Shakespeare's Globe in London in support of Reprieve. He played various concerts in Germany, Switzerland, Austria, Canada, Turkey and Australia in 2007 and 2008.