His foot seems on the line to me, though. The laws, as written, state "inside the penalty area" without any clarification about what "inside" means.
Plus, there is also the scope for the referee to think that Arsenal took the goalkick "quickly", which is now treated like a quick free kick, in that if you mess it up, tough luck.
I'm not sure there was any clear error here - the Watford player wasn't "clearly" inside the area looking to gain an advantage. He moved as soon as the ball was touched, and intercepted a bad pass, from which Watford scored.