Midfielder Seung-ho Paik and winger Demarai Gray put Tom Brady's outfit ahead before the break at St Andrews.
Seven-time Super Bowl winner Brady owns a minority stake in Birmingham, and they were made to sweat in the second half after winger Othmane Maama's effort.
The Blues, League One winners last season, claimed a fourth straight home victory, to trail sixth-placed Bristol by the smallest of margins in the English second division's table.
South Korea's Paik opened the scoring after half an hour with a low strike, netting for a third time in five games.
Jamaica's Gray then doubled the Blues' lead two minutes before the break, with the hosts firmly on top.
Five minutes into the second half, Watford had a great chance to halve the deficit, but Marc Bola had his effort tipped over the bar.
With half an hour left, Bola played a part in bringing his side back into the game, setting up Morocco's Maamma to make it 2-1.
As Javi Gracia's side looked for the equaliser, he replaced Maamma with experienced France midfielder Moussa Sissoko, but the 36-year-old was unable to help his side find the crucial second goal, leaving the Hornets in 15th spot.