What does a higher interest rate generally indicate about inflation?

A higher interest rate generally indicates higher inflation expectations because lenders demand higher returns to compensate for the decreased purchasing power of money over time. When inflation is anticipated to rise, the cost of borrowing increases as creditors seek to maintain their profit margins. This is because if they lend money at a fixed rate and inflation rises, the real value of the repaid amount diminishes.

Therefore, when you observe an increase in interest rates, it often reflects the market's expectations that inflation will increase in the future. In response to this inflationary outlook, the central bank may raise interest rates to curb excessive spending, which is a common economic strategy to manage inflation. Thus, higher interest rates typically signal that investors and borrowers foresee higher inflation, leading to the conclusion that higher inflation expectations are correlated with rising interest rates.