The 2-0 reverse means Villa have gone six games without a win, and while three of those were cup matches, their once strong position in the top four is suddenly under attack from Arsenal, who are just three points adrift.
Yet O’Neill insists his team are not getting nervous – and he has vowed the struggle will continue through the final 10 games of an arduous campaign.
“We are not nervous – we are excited,” he said. “Really, if you are not excited by the position we are in, you shouldn’t be playing.
“We are in this position because we deserve to be. It would be a shame to throw it up now without a fight – but I don’t think we will.”
Yet despite his bullishness O’Neill admitted Villa’s efforts in the opening 45 minutes were probably their most lacklustre of the entire season.
The visitors did not create a chance, with Gabriel Agbonlahor and Ashley Young both anonymous.
Even without injured pair Craig Bellamy and Robinho, City carried all the attacking threat and Shaun Wright-Phillips should have put them in front before he was upended by James Milner.
Elano kept his nerve to put the Blues in front from the spot with his first league goal since August.
And while Villa improved markedly after the interval, they created just two decent chances, which Shay Given saved from Gareth Barry and Young, allowing Wright-Phillips to wrap up victory two minutes from time.
City boss Mark Hughes, whose side moved up to eighth, said: “That was one of our most accomplished performances – if not the most accomplished.
“It is baffling at times why we cannot produce that kind of performance away from home, although in fairness, there have been some positive signs recently.”
Hughes was particularly impressed with Wright-Phillips who returned after a three-match ban and deservedly edged Elano for man-of-the-match honours.
“There is joy in his game,” enthused the City boss.
“He has always played with a smile on his face but your enthusiasm can soon be blunted if you are not playing every week.
“Shaun has come back from Chelsea as a better player but he has come back to what he regards as his club and I felt he did really well.”
Hughes confirmed new signing Nigel de Jong had been substituted with a knee injury, although he does not feel the damage, in an area where the Dutchman has suffered problems before, is too extensive.
And, after undergoing scans on Tuesday, he confirmed Craig Bellamy will be out for no longer than three weeks with the injury he suffered at West Ham on Sunday.
“It could be sooner but the prognosis is no longer than three weeks to get Craig back playing again,” said Hughes.
Like City, Villa have no weekend fixture after getting knocked out of the FA Cup by Everton.
O’Neill intends to take his players on a short break to Dubai, which he feels will get them ready for the challenge that lies ahead.
“We will come back and really stick at it,” he said.
“Maybe we are being a bit naive thinking we can challenge those top four sides, who have been up there so consistently over the last few years, but whatever happens, we should relish the challenge.”
MAN CITY: Given, Zabaleta, Onuoha, Dunne, Bridge, Wright-Phillips, Ireland, Kompany, De Jong (Fernandes 47), Elano (Bojinov 83), Caicedo (Evans 74).
ASTON VILLA: Friedel, Cuellar (Gardner 88), Davies (Carew 46), Knight, L Young, Milner, Petrov, Barry, A Young, Agbonlahor, Heskey.
Referee: Chris Foy.