Prices at the wholesale level, with food and fuel prices removed, fell 0.3 percent in July, according to the Labor Department, the best showing for core inflation in nine months. Including energy and food, wholesale prices edged up 0.1 percent, well below the 0.5 percent jump in June.

The report lifted the pall that has hung over the markets all summer, brought on as investors fretted about inflation and whether the Federal Reserve's pause in rate hikes last week would be short-lived. With prices falling, however, the Fed under new Chairman Ben Bernanke could engineer the "soft landing" Wall Street was looking for, balancing slower economic growth with inflation pressures and leaving corporate profits relatively intact.

"I think the feeling here in the market is that the Fed may have actually nailed it," said Bill Groenveld, head trader for vFinance Investments. "Of course, now we have to take a close look at earnings and hope they'll still be OK, but right now, overall you have to feel pretty good. I think this market could get exciting."

The Dow rose 132.39, or 1.19 percent, to 11,230.26.

Broader stock indicators also advanced. The Standard & Poor's 500 index rose 17.37, or 1.37 percent, to 1,285.58, while the Nasdaq composite index gained 45.97, or 2.22 percent, to 2,115.01.

Bonds also rose sharply on the government's inflation report, with the yield on the benchmark 10-year Treasury falling to 4.93 percent from 5 percent late yesterday. The dollar fell against most major currencies, while gold prices also slid.

Crude prices edged lower, with a barrel of light crude settling at $73.05, down 48 cents on the New York Mercantile Exchange.

The markets got additional support from a New York Federal Reserve report showing manufacturing activity in the region declined this month. The news added to growing evidence of a moderating economy, which would also serve to keep prices moderate and further encourage the Fed to avoid raising rates.

Wall Street remained concerned about inflation after the Fed announced a pause in rate hikes last week. Monetary policy makers continued to say that they may yet raise rates, which led to worries that the market would see more up-and-down trading based on the latest economic data. With the PPI report, however, traders believed there's a stronger chance that inflation is contained for the long term.

Still, another Labor Department pricing report, the consumer price index, is due tomorrow, and while the PPI number bodes well for the CPI, there's still a chance that lower prices have yet to work their way through to the average consumer.

"This is nice right now, with PPI and lower oil and good earnings, but all that could change tomorrow if you get a higher CPI number," said Brian Williamson, an equity trader at The Boston Company Asset Management. "Volume is good, but still a little light, so you may be seeing some people holding off on moving until tomorrow's number."

In corporate news, Dell Inc. rose despite the announcement from the Round Rock, Texas, company that it would recall some 4.1 million notebook batteries made by Sony Corp. because they can burst into flames. The stock added 84 cents, or 4 percent, to $22.08 on the Nasdaq stock market.

Wal-Mart Stores Inc. slid 55 cents to $44.55 after the world's largest retailer posted its first profit decline in a decade as the cost of selling its German operation pulled second-quarter earnings down 26 percent.

Jones Apparel Group Inc. also dipped after a report today indicated the apparel-maker and retailer would stop seeking to auction itself off after no buyer came forward. Its shares lost 48 cents to $29.07.

Shares in Atlanta-based Home Depot Inc. rose $1.18, or 3.6 percent, to $34.44 after the home improvement retailer posted strong earnings.

Advancing issues outnumbered decliners by more than 5 to 1 on the New York Stock Exchange, where volume came to 1.52 billion shares, compared to 1.41 billion traded yesterday.

The Russell 2000 index of smaller companies was up 16.10, or 2.36 percent, at 697.83.

Overseas, Japan's Nikkei stock average fell 2.6 percent, Britain's FTSE 100 was up 0.46 percent, Germany's DAX index was up 1.49 percent and France's CAC-40 was up 1.35 percent.