I've been using private-public key logins on my home server for several years but I've always left PasswordAuthentication yes
so that if anything untoward happened I could still login.
Of course the likelihood of anything untoward happening is hugely increased by leaving password auth enabled.
So if I set PasswordAuthentication no
I obviously won't be able to login to SSH using a username/password.
But can I still login to the machine locally using a system username/password?
I'm assuming yes, since logging in locally to the physical machine would have nothing to do with SSH. But before I go ahead and disable password auth I wanted to make 100% sure.
Yes you will be able to locally login using an username/password since this is the configuration for the sshserver only and doesn't affect the local login procedure.
You are correct in your assumption.