Ms Mowlam said the banning order on the Loyalist paramilitary force - founded by Billy Wright who was shot dead in the Maze by the Republican Irish National Liberation Army, the INLA - was lifted on the basis of security information.
The Northern Ireland Secretary said it was too soon to lift the banning orders on three other republican groups: the Continuity IRA, which has not declared a ceasefire; the Real IRA, which was responsible for the Omagh bomb massacre and the INLA. They have both declared ceasefires.
The LVF was involved in a spate of tit-for-tat killings last January sparked by the shooting of Billy Wright when six Catholics, not associated with terrorism, were murdered.
Ms Mowlam said: "I am now satisfied that they have established a complete and unequivocal ceasefire and over a significant period of time, since May 1998, they have demonstrated that that ceasefire is being maintained."
She said the lifting of the ban also recognised the significant contacts that the LVF had made, via an unnamed intermediary, with the body set up to handle decommissioning of terrorist weapons in Ulster.
The lifting of the ban has to be approved by Parliament, and it was given the support of the Tories. But Andrew Mac kay, the Tory spokesman on Ulster, urged the Loyalist group to show a lead by fulfilling its promise by decommissioning its illegal arms and explosives.
He also called on the Prime Minister to call a halt to the release of prisoners under the Good Friday Agreement until the IRA, the LVF and other groups have started decommissioning their weapons. The LVF has 19 prisoners in the Maze and 13 in another Ulster prison.
"This is an ideal opportunity for Tony Blair to tell all the paramilitaries that there will be no more early release of terrorist prisoners until there is substantial and verifiable decommissioning," Mr Mackay said.