I have this problem on my 2G iPod Touch also.
I re-synced, and even deleted the iPod photo Cache that is created in the folder being synced...still many of my photos that were sharp and looked great before, now look bad.
Also, I sync my iPad to the same folder of photos, and they look sharp and great on the iPad, and blurred on the iPod Touch...?😕😕
Anyone know what this issues is?