I also have had an upgrade problem going from 1.2.1 to 1.2.2. I have the full install of pfsense on an 80gb hard drive, so space isnt an issue. I did the autoupdate and it found the newer version and downloaded it. However, as soon as the download finished it just gave an error that it couldnt do the update.
So I manually download the image from the updates directory (latest.tgz) and installed it manually. However, that failed as well of course because the manual update process has to have the file named pfsense*.tgz.
Renamed the latest.tgz to pfsense_latest.tgz and it worked perfect.
Does the autoupdate process require the file to be named pfsense_* before it will run like the manual process does?