The game most certainly implies that Hojo was attempting to have Red XIII mate with Aeris, during the scene in question.

In fact, just after this scene, Red XIII says "I have a right to choose, too. I don't like two-legged things."

I think this is a great scene, specifically because of the fuzzy logic of Hojo. Does he really think that Red XIII and Aerith would be able to have traditional offspring? Is this truly his intention? Probably not, but that's not stopping him.

It quickly establishes him as the sick individual that he is.