I suspect it will not be long before 128GB of USB-stick class flash storage (an iPod doesn't need a super-fast SSD) is actually cheaper than a 160GB 1.8" HD. I wouldn't be surprised if that point has already been passed, in which case the iPod Classic will last until Apple's current stock of/supply contract for 1.8" HDs runs out.
There's still a huge market for 2.5/3.5" hard drives, and flash can't yet beat them for bytes-per-buck - but I don't think smaller HDs are going anywhere when flash is so much better suited for small mobile devices in terms of size, power consumption and shock-resistance. 1.8" HDs will become a niche product for legacy devices and the prices will go up (at least in relation to Flash).