NEW YORK (CNNMoney.com) -- Stocks rallied Tuesday on bets that the morning's mild inflation report means the Federal Reserve won't have to restart its recently paused interest-rate hiking campaign.

The Nasdaq composite (up 45.97 to 2,115.01, Charts) gained 2.2 percent. It was the third best day of the year on a point and percentage basis for the tech-fueled index.

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The Dow Jones industrial average (up 132.39 to 11,230.26, Charts) gained 1.2 percent and the broader Standard & Poor's 500 (up 17.37 to 1,285.58, Charts) index climbed 1.4 percent.

Stocks began the day on a positive note and kept going from there. The advance followed a mild read on wholesale inflation in July, which fanned hopes that the Fed can keep interest rates steady.

Such hopes were further reflected in the Treasury bond market, where prices surged, lowering the corresponding yields.

A slide in the dollar also added to such bets. Lately, a falling dollar has indicated that international investors - the main buyers of dollars - think the Fed is nearly done, said Paul Mendelsohn, chief investment officer at Windham Financial Services.

Whether the rally will be Wall Street's latest one-day wonder or something more will be partly determined by Wednesday's read on consumer inflation (CPI), a more telling indicator than PPI of pricing pressure, Mendelsohn said.

The CPI number, particularly at the core level, is a "make it or break it" report for the current rally, Mendelsohn said.

CPI, due at around 8:30 a.m. ET, is expected to have risen 0.3 percent in July, according to a consensus of economists surveyed by Briefing.com. CPI rose 0.2 percent in June.

Core CPI, which excludes volatile food and energy prices, is expected to have risen 0.4 percent in the month, after rising 0.3 percent in the previous month.

"If we get a lower than expected number, we could really see the rally continue," Mendelsohn said. "If the numbers are worse, you could see us give back all of today's advance."

Also at 8:30 a.m. ET, reports are due on housing starts and building permits in July.

A heavy day for economic news, Wednesday also brings reads on July building permits and housing starts as well as capacity utilization and industrial production. The government's weekly oil inventories report is due also at around 10:30 a.m. ET.

Stocks that are likely to be active Wednesday morning include Applied Materials (Charts) and Abercrombie & Fitch (Charts).

After the close, Applied Materials reported quarterly earnings, revenue and gross margins - a key measure of profitability - that rose from a year ago and topped expectations. Shares rose around 2 percent in extended-hours trading.

Also after the close, Abercrombie reported quarterly earnings and revenue that rose from a year ago and beat estimates. The clothing retailer also issued earnings guidance for fiscal-year 2007 that is higher than analysts' estimates. Shares gained more than 8 percent in after-hours trading.

The Producer Price Index (PPI), a measure of wholesale inflation, rose 0.1 percent in July, after climbing 0.5 percent in June. Economists surveyed by Briefing.com thought PPI would rise 0.4 percent.

Core PPI, which strips out volatile food and energy prices, fell 0.3 percent after rising 0.2 percent in June. Economists thought it would be unchanged.

The report sent Treasury yields lower and stocks higher as investors bet that the Federal Reserve won't have to restart its rate-hiking campaign in September.

Last week, the central bank held a key short-term interest rate steady at 5.25 percent after lifting it 17 times in a row since June 2004. The rationale was that slowing economic growth would slow inflation as well.

However, market watchers have been skeptical about such a scenario, and have worried that the Fed might have to raise rates again at the next policy meeting Sept. 20.

The PPI report seemed to make a case for the Fed's ability to keep rates where they are. However, it's still early to make such a call, said Jane Caron, chief economic strategist at Dwight Asset Management.

She said that the markets seemed to be treating the report as more positive than it really was.

"I think the market is seeing it as proof of slowing inflation, but I think that's jumping to conclusions," Caron said, noting that without the slide in volatile auto prices, the core would actually be positive for the month, rather than negative.

A separate report showed slower-than-expected manufacturing growth in the NY area in August.

The NY Empire State index fell to 10.3 in the month from an upwardly revised 16.6 in the previous month. Economists surveyed by Briefing.com thought it would fall to 14.8.

The advance covered most sectors, with 28 out of 30 Dow components rising, led by Home Depot, which gained on its strong earnings report.

Home Depot (up $1.18 to $34.44, Charts) was the Dow's biggest advancer, gaining 3.6 percent after reporting earnings that rose from a year earlier and topped forecasts by a penny a share.

That overshadowed the company's prediction that earnings growth for the rest of the year will be on the lower end of its previous guidance.

The Dow's financial components bounced, with Citigroup (up $0.69 to $48.41, Charts), JP Morgan (up $1.15 to $45.04, Charts) and American Express (up $1.01 to $52.81, Charts) all rising soundly.

Dow tech issues such as Hewlett-Packard (up $0.70 to $33.99, Charts) and Intel (up $0.26 to $18.13, Charts) jumped too, reflecting gains in the overall technology sector.

Intel, Marvell Technology (up $1.14 to $18.62, Charts) and Advanced Micro Devices (up $1.00 to $20.87, Charts) were among the chip issues boosting the Philadelphia Semiconductor (up 15.26 to 425.17, Charts) index, or the SOX, by 3.7 percent.

A standout to the downside was Dow stock Wal-Mart Stores (down $0.55 to $44.55, Charts), which lost 1.2 percent. The leading retailer reported quarterly earnings that rose from a year earlier and met estimates. Wal-Mart also issued a third-quarter earnings forecast that sets the midpoint below analysts' expectations.

Dell (up $0.84 to $22.08, Charts) stock managed to gain 4 percent even after announcing late Monday that it will recall 4.1 million Sony-produced computer notebook batteries because they are a fire hazard. However, the PC-maker said it doesn't expect a substantial impact on business as a result of this.

Market breadth was resoundingly positive. On the New York Stock Exchange, winners trounced losers by more than five to one on volume of 1.51 billion shares. On the Nasdaq, advancers beat decliners by three to one on volume of nearly 1.80 billion shares.

The Nasdaq managed gains Monday after a broader rally petered out by the close, despite falling oil prices and a cease-fire in the Israel-Hezbollah war.

Oil prices were a little lower Tuesday.

U.S. light crude for September delivery eased 48 cents to settle at $73.05 a barrel on the New York Mercantile Exchange.

Treasury prices jumped, lowering the yield on the 10-year note to 4.93 percent from 4.99 percent late Monday. Treasury prices and yields move in opposite directions.

The dollar slipped versus the yen and the euro.

Gold prices slipped $6.40 to $632.90 an ounce.

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