Now it's official, from the Microsoft XML Team:
Our users have made it very clear that they want an XSLT 2.0 implementation once the Recommendation is complete. A team of XSLT experts is now in place to do this, the same people who have been working on the XSLT enhancements that will be shipped in the forthcoming "Orcas" release of Visual Studio / .NET 3.5. Orcas development work is winding down in advance of Beta releases over the next several months, so there is no possibility of shipping XSLT 2.0 in Orcas. The XSLT team will, however, be putting out Community Technology Previews (CTP) with the XSLT 2 functionality and appropriate tooling as the implementation matures. The eventual release date and ship vehicles (e.g. a future version of .NET or a standalone release over the Web) have not been determined, and depend on technical progress, customer demand, and other currently unknowable factors.
Good. Very good news for those who invested in XSLT. XSLT 2.0 is sooooo much better,so much easier to develop with language. And I'm sure this new Microsoft XSLT 2.0 engine is gonna rock.