I found the solution. A simple reboot wont work, in my case it was a new phone, but others have reported a similar problem with older (working) phones that had an upgrade to iOS 4.
1. disconnect the iPhone
2. Power down the Iphone (slider to power off)
3. power on the radio
4. connect the iPhone to the usb port/iPod kit cable
5. the iPhone will reboot, if it doesn't then power it on.
6. wait for reboot to complete.
Try to play a tune over the ipod form a the car. It should now work. This solution works for various cars. Apparently it forces the radio and iPhone to renegotiate the protocols. Worked for me