How does an increase in inflation typically affect the yield curve, particularly in relation to bond prices?

When inflation increases, it usually leads to higher interest rates because lenders want to be compensated for the decrease in purchasing power of money over time. As interest rates rise, newly issued bonds offer better returns, which makes existing bonds with lower rates less attractive. This causes the prices of existing bonds to fall, as investors will pay less for them. The yield curve, which shows the relationship between interest rates and bond maturities, often becomes steeper when inflation rises, indicating that long-term rates are increasing more than short-term rates. For example, if a ten-year bond’s yield rises from 2% to 4% due to inflation, the price of that bond will drop significantly, reflecting the new higher yield available in the market.