Neuronal activity leads to arteriole dilation and increased blood flow in retinal vessels. This response, termed functional hyperemia, is diminished in the retinas of diabetic patients, possibly contributing to the development of diabetic retinopathy. The mechanism responsible for this loss is unknown. Here we show that light-evoked arteriole dilation was reduced by 58% in a streptozotocin-induced rat model of type 1 diabetes. Functional hyperemia is believed to be mediated by glial cells and we found that glial-evoked vasodilation was reduced by 60% in diabetic animals. The diabetic retinas showed neither a decrease in the thickness of the retinal layers nor an increase in neuronal loss, although signs of early glial reactivity and an upregulation of inducible nitric oxide synthase (iNOS) were detected. Inhibition of iNOS restored both light- and glial-evoked dilations to control levels. These findings suggest that high NO levels resulting from iNOS upregulation alters glial control of vessel diameter and may underlie the loss of functional hyperemia observed in diabetic retinopathy. Restoring functional hyperemia by iNOS inhibition may limit the progression of retinopathy in diabetic patients.