I just assumed they established those recommendations by other means, such as your subscriptions (doesn’t involve watch history) or location (also doesn’t involve watch history), but I think you’re right. They could easily do what tiktok is planning for:
If personalized recommendations are turned off, TikTok’s feeds will instead suggest videos to European users based on what’s popular in their area and around the world.
That they turned it off completely strikes me as them throwing a hissy fit to get you to turn it back on, like they’ve done with other services in the past. Previously if you owned a Pixel phone, but turned off all tracking info in your phone settings, then simple tasks in virtual assistant would turn off, like weather updates, direction requests via maps, ect. They wouldn’t work and instead it would respond with “please turn on browser and app history in privacy settings”.
I expect most people to acquiesce because they’ll think they “broke” something, but really Google has zero incentive to provide any service if they are unable to tailor ads and media to you from your usage data, because they can’t charge half of what they could otherwise to serve you ads.