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I've done some Googling and I can't seem to get a straight answer anywhere.
It would appear, from what I can gather, that DVD/Blu-Ray playback is limited to either 480p or 1080i/p. One experiment that I did which would suggest this is I watched part of a Blu-Ray movie with the output set to 720p, and it looked "okay-ish", but when I switched it to 1080i, it looked noticably better.
Now, one important piece of the puzzle is that my TV's highest resolution is 720p. HOWEVER, it can accept a 1080i signal and downscale it to 720p. In the case of the Blu-Ray movie, the 1080i option downscaled to 720p looked better than just plain 720p. I'm assuming this is becuase the PS3 does not play video at native 720p, but rather upscaled 480p.
Do I need an HDMI cable for the PS3 to output at native 720p for movies? Games seem to be perfect at 720p.
If you've updated your firmware the PS3 will output 720p just fine. You do not need an HDMI cable for it, component will do it, assuming your display takes 720p over component (which it should).
So to re-confirm: the PS3 DOES play video at native 720p if you've updated your firmware.
If it looks to you going from a recieved 1080i to 720p - just leave it that way? I don't think you run the harm of hurting anything and whatever looks best is most important.
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So to re-confirm: the PS3 DOES play video at native 720p if you've updated your firmware.
upscaling 720p content to 1080 then back down again is not so good.