After 20 games, City have scored 61 goals, the most in the Premier League and allowed the fewest.
Gray got a consolation for Watford in the 82nd minute slotting home a low cross from Andre Carillo.
City beat Watford 6-0 and 5-0 in their two previous meetings and it threatened to be a similar thrashing from the moment Sterling hooked in from close range following Leroy Sane's fierce center across the face of the six-yard box.
Aguero missed two chances before halftime, and another soon after the break.
It was 2-0 after 13 minutes when defender Christian Kabasele put the ball into his own net before fit-again midfielder Kevin De Bruyne saw his free-kick pushed onto the crossbar by Hornets keeper Heurelho Gomes. A lot of games to play.
City are now 15 points ahead of second-placed Manchester United, while they have drawn Basel in the last 16 of the Champions League. We are going to kill [the players].
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Buffalo possessed the ball for over 20 minutes in the first half, but they were only able to put three points on the board. No matter what happens during the course of a game, he has that belief that he can go down and lead us on any given drive.
"We are very happy David is back, we don't know how long but he made another exhibition - he's essential, he showed how important he is for us".
Fernandinho has credited Guardiola with making him a better player as well as turning City into one of Europes most feared teams.
The 23-year-old has been one of City's standout players this season, also establishing himself as one of England's premier central defenders in the lead-up to the World Cup.
Fernando Llorente scored his first Premier League goal for Tottenham against his former club as Spurs won 2-0 amid a downpour at Swansea City.
I think, even for the neutral, they look at Manchester City and think this is wonderful stuff that they are seeing.. Fixture pile-up will kill players: Pep Pep Guardiola claimed the fixture pile-up over the holiday season could "kill" players.
'There's a learning curve while you're injured as well and that's how I try to take it, but to come back and get three goals, three points, is a good way to come back'.
"I think this is not going to happen because tradition is tradition but just think about it a little for the players please - they are artists, the reason why all together we are here".