One persistent rumor has been that of an "iPhone Nano," a tiny iPhone with a smaller screen and far less memory. Apple’s been working on a way to let you access your iTunes library online, which might let you get to your music and apps without needing the expensive flash memory chips that a regular iPhone has. That would make the iPhone Nano cheaper as well as smaller.
On the other hand, Apple normally just sells last year’s model at a reduced price, for people who want a cheaper iPhone. Plus, screen resolution issues make a dramatically smaller iPhone unlikely ... so file this one under "maybe."