Preview at WWDC likely in June, followed by September launch.
Rumors of a 7.85-Inch 'iPad Mini' Revived (Again) for Late 2012
However, in order to cope with increasing market competition including the 7-inch Kindle Fire from Amazon and the launch of large-size smartphones from handset vendors, Apple has been persuaded into the development of 7.85-inch iPads, the sources indicated.There's been enough talk of such a device that it seems certain that Apple has at least been prototyping one over the past year. This previous mockup of such a device was discussed a year ago as a possibility:
Previous mockup of a 7-inch "iPad mini"
Previous rumors have suggested that a 7.85-inch iPad would carry the same resolution (1024x768) as the current iPad. This would open the door to Apple differentiating their new iPad with a much higher resolution Retina display, while offering the old resolution on a physically smaller device.
Given the number of ongoing rumors, it seems certain that Apple has been experimenting with a 7.85-inch iPad. We'd guess its ultimate arrival will depend on how the market responds to the Kindle Fire and similar tablets in the coming year.