The rumor that Microsoft is building a phone has been around since the day the Surface was announced. We heard previously from China that Microsoft has been working on the device for several months and now WPcentral, who has a strong record for rumor accuracy, is claiming that their sources have confirmed that the device does exist. In addition, BGR, who has been hit or miss on rumors, also claims to have insider information that Microsoft is building a phone.
Other than Microsoft building a phone, we know nothing else about the device. We can assume that it will run Windows Phone 8 (provided it launches in the near future) and that's it. We have not heard of any specs, size, or features that the mythical device may include. Heck, it could be possible that Microsoft is building a reference device but again, we do not anything else about the device.
If Microsoft does make a play into the phone market, it will be interesting to see how Nokia, who has put all of its chips in the Windows Phone pot, will react. Nokia is considered Microsoft's premier partner and many expected Nokia to provide the flagship phones that Microsoft wanted for its platform. If Microsoft does build its own phone, it would be a slap to the face of those vendors who gambled with Windows Phone early on only to have Microsoft enter the retail segment to eat into the already low market share.
To go one step further, albeit with even more speculation, when we pinged Microsoft about the China article and a first party device, their comment was vague but did not deny the information:
"We are big believers in our hardware partners and together we’re focused on bringing Windows Phone 8 to market with them."
The rumor appears to have weight and we have already seen the Surface tablet that many would have considered blasphemy a few years back; so a phone is not outside the realm of possibilities.