That is likely not intended so I guess it's probably inherent to how Xen and/or their I/O layer do the resource allocation.
I, too, have seen these freezes occasionally on small instances. If you think that is harsh then try one of the new micro's. ;-)
Anyways, I haven't had such a freeze last longer than a minute yet, and the instance would always recover. If yours does not recover then that would clearly be a bug.
When you select your instance-type then you get to choose between "Low", "Moderate", "High" and "Very High" I/O performance.
Want to take a guess at which instance types suffer first when there is high I/O demand or contention?