As currently configured, the iPod Touch is less seamless as a book reader than the Kindle, because it's a multi-use device. It plays music and videos, and therefore it has a lot of appeal for younger folks. However, there's no denying even the current (small screen) iPhone/Stanza app combination is doing well as an e-reader. So, I see it shaping up as more of carving up the market rather than a head-on fight. Older folks who value screen clarity and eye comfort will stick with the easy-on-the-eyes, easy-to-use Kindle (and the Sony), and the young and hip will go with iPhone and iPod Touch. But whether it's hip to have a 7-inch iPod is another question. The appeal of the iPhone/iPod Touch is that it's so small, it's easy to carry. I carry my Kindle in my purse pretty much all the time, but I don't qualify as hip.
On a related note, GalleyCat had another post about a rant on Booksquare, a blog by Kassia Kroszer, on e-book pricing—very entertaining and a lot of really good comments from folks who buy and sell e-books. Most of the heat comes from pricing by ScrollMotion as opposed to Stanza or Kindle.