because the last thing apple wants is sales of a $600 product taking away sales from a $300 product

From CNN.com:

Another analyst Gene Munster of Piper Jaffray said he expects Apple to bring out iPods that resemble iPhone, which features such as a touch-sensitive screen, later this year. Such products would help stop iPhone eating into iPod sales.

Same article, different "analyst":

"We believe that iPod Nano will be converted into a phone because it's probably the only way for Apple to launch a lower end phone without severely cannibalizing iPod Nano," he said noting that the new phone could have "rather limited functionality."

Yes, why would anyone buy a iPod Nano that only plays music when they could get a iPhone with "rather limited functionality" that requires a two-year service agreement with AT&T? (Plus, I will be impressed if Apple was able to make an iPhone the same size and sell roughly for the same price as a Nano.)