Before a huge Boxing Day festive crowd at the MCG, Ryan Harris led the home side's attack to have the beleaguered tourists under pressure after being sent into bat.
The Australians' tight bowling line restricted the English scoring and picked the wickets of opener Michael Carberry and Joe Root in the middle session.
At tea, the tourists were 135 for three off 54 overs with Kevin Pietersen on 20 off 57 balls and Ian Bell not out 11 from 35 balls.
But Coulter-Nile was unable to stay within the field of play in taking the catch and Pietersen was awarded a six.
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Carberry, who was dropped in the slips on two, had done all the hard work and was beaten by a terrific movement off the pitch from Watson in the 34th over of the innings.
Harris removed Root with an outswinger, enticing an edge to 'keeper Brad Haddin for 24 in the 43rd over.