People use Google services all the time on the iPhone and Google is happy to give it to them. I personally use Google Sync to sync my mail, contacts and calendars OTA, although I am sure Apple would prefer me to pay for a MobileMe subscription.
I think Google wanted a bit more freedom, like their Google Voice app was blocked because of Apple and Apple wouldn't have let Google integrate Google Sync nicely into the iPhone because they want to sell MobileMe so Google had to do a work around with Microsoft Exchange. Secondly, and more importantly I think Google wanted to get more people using Google, so to do that you have an Android phone which requires a Google Account. Plus they probably looked at the market and seen that no one else was even close to the iPhone so to get on more handsets they had to create their own that they would control.
Personally I think it is the media making something out of nothing. Sure Steve Jobs can be outspoken, but at the end of the day they are both businesses. Apple aren't going to dump Google on the iPhone, iPad or Mac. People want to watch YouTube and use Google to search as good as services like Vimeo and Bing may be. At the same time Google needs Apple. The iPhone is still the most popular smart phone, the Mac continues to grow and the iPad is expected to be huge. The more devices it is on, the better for Google.
Both companies could probably go on without each other, but people would be a bit shocked at first if they couldn't get YouTube on their phone or they was suddenly presented with Bing. At the same time Google could pull out from the iPhone, Mac and iPad but it would lose a lot of mindshare and potential revenue.