I expect an update in June, but not the huge leap in capabilities that some predict. In other words, no iPhone HD. Instead, I expect 32 GB or maybe even 64 GB models, bump in battery life, faster processor, something like that. I also expect Firmware 3.0 with some nice new features.
Apple probably has a iPhone HD prototype, but given the state of the economy, which most certainly won't be "all better" by this summer, I can't see them putting out a premium-price phone. Terrible timing. They will shelve it for another year. The existing iPhone already has a great screen.
I also don't see any "special deals" for existing iPhone customers that are still in contract. Why would they do that? I think many here forget sometimes that AT&T and Apple are in this business to make money. Remember the huge hit AT&T told their shareholders they'd take on iPhone 3G subsidies? Yeah, they want that money back through data costs. They are not just going to reset the subsidy all over again.