That is the GPU failing. It should be a free swap out as it's still within the factory warranty period.
BTW ... I'm awaiting equipment from a local supplier to allow me to do GPU re-balling, which will sort out such an issue. I'm quite excited about adding this to my repertoire.
Spot on. I had the same problem. Was playing GTA IV and the colours went all funny. A day or 2 later there was no video output out all. Phone Microsoft support and get a reference, then swop it out. (Seems to be popular with the late 2007 models)