I think graphics will continue to improve but the publisher/developer mindset of needing to have the best graphics will wane.
Nintendo HAS shown that you no longer need graphics to sell games. In fact high-end graphics now limit - no increase - your audience. Cutting edge graphics sell a game as a game for 'gamers'. When Joe or Jill Blow see those graphics they immediately think - that's not for me that's for Joe Jr.
The other big problem is PC. Sure it offers the highest of high end graphics but only maybe 1-10% of PC users have that. The other 90+% have graphics cards that would struggle to even play some Xbox games let alone 360.
The other factor - seemingly lost on Sony - is that the most graphically powerful console has never won a console war. PS2 was the least powerful of the 3 of last gen. Wii is the least powerful this gen. Both dominated.
Cost is the other big factor BUT not THAT big a factor as middleware providers will always be there to provide solutions to make maximizing high-end graphics more affordable.
So I expect next-gen consoles to be more powerful but not dramatically more powerful.