In season 4, Giles was considering turning his relationship with Olivia, specifically, into something more. The dream shows him struggling with the realization that if he continues to commit his life to fulfilling his duties as watcher, only, Buffy will be the closest he ever gets to having a child. At the carnival, it seems that he is making peace with that. But later in Spike's crypt he sees Olivia crying next to an empty stroller. What does he want? Should he end things with her because he won't be able to give her what she wants?
Anyway, yes, it's specifically Olivia that he is considering in the dream, as he ponders his own future and what kind he could have. Sure he might have truly preferred to live his life with Jenny but that was no longer an option. This dream was about what to do next, and an overall evaluation of how he was living his life, not a lament about what could have been with Jenny.