If to be true, sensationalism is what I suspect. For an iPod of this size, this would signify a change in product lineup, for the iPod shuffle would become nonessential. If we see a storage bump in the iPod touch, the iPod classic would have no need. Could we see an iPod lineup of two? Doubtfully so, as I see a refocus on touchscreen devices, with relevance to the iPad.
In truth, I personally believe this rumor to be associated with the shuffle. It's far more sensical for a 2 inch screen to appear in this specific iPod model. Either way, I'm excited.
This is what I see as an ideal lineup:
<iPad>
64GB - 128GB - 256GB
7 Inch Screen - 10 Inch Screen
<iPhone>
16GB - 32GB - 64GB
3.5 Inch Screen
<iTouch> Rebranded
32GB - 64GB - 128GB
3.5 Inch Screen - 5 Inch Screen
<iNano> Rebranded
8GB - 16GB - 32GB
1.7 Inch Screen - 2.8 Inch Screen
Unlike the others, the iNano would pertain to a closed iOS, where as it is now, certain specific apps will be downloadable, with it geared emphatically towards music. For a device of that size, music would be the focus.
I love speculating, and it's been long overdue for a re-imagined iPod lineup.