With the nation's retailers reporting a generally positive July, typically a slow month for sales, investors were reassured about the strength of consumer spending. In addition, the Institute for Supply Management's services index came in below expectations, evidence that economic growth is moderating.

The Fed meets Tuesday to determine whether the nation's benchmark rate should be pushed up a quarter percentage point to 5.5. percent. The ISM data, along with a Commerce Department report showing slower-than-expected growth in factory orders, could give policy makers enough evidence of a slowing economy to result in a pause in rate hikes.

"Both reports bode well for a soft-landing scenario" which would maintain economic growth while keeping inflation in check, said Peter Cardillo, chief strategist and senior vice president at S.W. Bach & Co.

The economic data allowed investors to look past rate hikes from the European Central Bank and Bank of England. With rates rising in Europe, the Fed may feel comfortable with another rate hike, which would keep U.S. investments competitive. Additionally, tomorrow's monthly job creation report from the Labor Department is expected to serve as a better gauge of the Fed's intentions, with strong job growth considered a signal for more rate hikes.

The Dow Jones industrial average rose 42.66, or 0.38 percent, to 11,242.59.

Broader stock indicators also advanced. The Standard & Poor's 500 index added 1.72, or 0.13 percent, to 1,280.27, and the Nasdaq composite index gained 13.53, or 0.65 percent, to 2,092.34.

Bonds traded in a narrow range, with the yield on the benchmark 10-year Treasury note steady at 4.96 percent from late yesterday. The dollar fell against most major currencies, and gold prices also slumped due to the European rate hikes.

Crude oil futures fell after weather forecasters said Tropical Storm Chris was weakening and may not affect refineries and oil rigs in the Gulf of Mexico. A barrel of light crude settled at $75.46, down 35 cents, on the New York Mercantile Exchange.

Investors favoring an end to interest rate hikes were cheered as weekly first-time unemployment claims rose slightly. Analysts say a softening labor market could allow the Fed stop raising rates. First-time claims rose to 315,000 from 301,000 the previous week.

"You're seeing two days of buying now in front of tomorrow's jobs report and the Fed meeting this week, and that tells me the market is expecting the Fed to stop raising rates," said Jack Ablin, chief investment officer at Harris Private Bank. "If (Fed policy makers) do pass, we may get a rally, but if they raise rates, I think the downside for stocks would be greater than the upside if they don't raise."

Interest rates aside, investors welcomed the latest round of retail sales reports. Wal-Mart Stores Inc. added 36 cents to $44.73 after reporting a 2.4 percent gain in same-store sales, or sales at stores opened at least a year. And Limited Brands Inc., operator of retailers such as Victoria's Secret and Bath & Body Works, jumped $1.32, or 5.4 percent, to $25.81 after posting a 7 percent rise in same-store sales.

Target Corp. posted a lower-than-expected 3.1 percent increase in same-store sales, but saw its stock rise 61 cents to $46.39 as the company said it would meet or beat Wall Street's quarterly profit estimates.

Gap Inc. lost 51 cents, or 3 percent, to $16.61 after the clothing retailer said its sales dropped 4 percent for July.

In earnings news, conglomerate Tyco International Ltd. said its quarterly profits fell from a year ago due to one-time charges and stock option expenses. The results missed Wall Street's forecast, and Tyco fell 41 cents to $25.95.

Advancing issues outnumbered decliners by about 3 to 2 on the New York Stock Exchange, where consolidated volume came to 2.9 billion shares, compared with 2.78 billion traded yesterday.

The Russell 2000 index of smaller companies was up 7.57, or 1.09 percent, at 704.38.

Overseas, Japan's Nikkei stock average edged 0.04 percent higher, but European markets tumbled after the rate hikes there. Britain's FTSE 100 closed down 1.58 percent, France's CAC-40 dropped 0.85 percent for the session, and Germany's DAX index lost 0.72 percent in late trading.