I think they're plenty of room for graphics growth (although diminishing returns all seems likely).
The bigger challenge I think with the trend is how to keep cost under control - i.e. higher and higher res textures, more diverse textures, more detailed character models, etc. All this tends to cost more, raising the development cost and impacting developer ability.
Looking at this gen so far I think we're going to see (particularly given the praise given to 360 SDK and complaints about PS3's first SDK) a big focus on having very efficient SDK and tools to lower costs and development time.
Right now I'm very curious about the new ID tech, Crytek's move to consoles and what the next iteration of Unreal engine will look like (plus of course where Guerrilla and Naughty Dog take their tech next).
Try to be reasonable... its easier than you think...
