Branislav Ivanovic lashed home a fierce 25-yard shot in the 31st minute to end City's 100 per cent winning record at home in the league and earn Chelsea the double over most pundits' favourites for the title. The visitors could have won by more, hitting the goal frame three times and threatening almost every occasion they broke forward.
It meant Arsenal returned to the top of the standings, with a two-point lead over City and Chelsea, in what is proving to be a thrilling title race. Chelsea manager Jose Mourinho continues to rule his evolving team out of contention, but few will take him seriously after this performance.
"Two horses and a little horse," was Mourinho's description of the title race, which has 14 more matches to run. "A little horse that still needs milk and to learn how to jump. A horse that next season can race."
City has been the league's thoroughbreds this season, winning all 15 of its domestic home games and scoring 115 goals in all competitions. Arsenal, Manchester United and Tottenham — among others — have all been crushed at Etihad Stadium this season.
A win here would have put six points between City and Chelsea — to many, the second favourites for the title, despite Mourinho's protestations to the contrary — but it's all to play for now.
"I think that for Chelsea it was a decisive game, but not for us," City manager Manuel Pellegrini said.
Mourinho is renowned around the football world as the master defensive strategist. Few will forget how his Inter Milan side nullified Barcelona in the 2010 Champions League semifinal at the Camp Nou, while Chelsea has already ground out 0-0 draws at Manchester United and Arsenal this season.
It was different here, though. Chelsea counter-attacked with such pace and purpose, and hounded City's much-lauded ball-players into sloppy mistakes, that the visitors could easily have won by three goals. Samuel Eto'o hit the bar and the excellent Nemanja Matic and Gary Cahill struck the post.
Bayern Munich is the only team to have beaten City at Etihad Stadium this season and Chelsea's supreme display had echoes of that dismantling in the Champions League back in September.
It was the first time City failed to score at home in the league since November 2010 — a streak of 61 matches. The home side badly missed injured top scorer Sergio Aguero but also holding midfielder Fernandinho, who was ruled out at the last minute with a muscle injury.
Martin Demichelis — a centre back — filled in in central midfield and couldn't stop Chelsea's midfielders running amok.
"We love it — we love the big games," said Mourinho, who revealed that he left the club's masseur, Billy McCulloch, to do the pre-match team talk. "Obviously when you love it, maybe you feel extra motivated for that."
Before Ivanovic put Chelsea in front, Ramires had a curling shot saved after running onto a pass from Willian, who had led a 4-on-1 attack on City's beleaguered defence.
The goal arrived soon after, with City captain Vincent Kompany diving to block Ramires' shot but seeing the ball squirt out to Ivanovic, who drove a powerful first-time shot with his left foot into the bottom corner.
And moments before halftime, Eden Hazard skirted round Pablo Zabaleta and crossed for Eto'o to smash a shot against the top of the bar.
City's defensive frailties were being exposed but the hosts were also quiet — by their standards — going forward. Alvaro Negredo was virtually anonymous, although Pellegrini later said the striker wasn't 100 per cent, and the only attacking thrusts were provided by Yaya Toure, who curled one shot over, set up David Silva for a great chance that was glanced just wide and just missed a fizzing cross from Aleksandr Kolarov.
Mourinho had City just where he wanted them — and it almost got worse for Pellegrini's side when Matic strode forward and crashed a 30-yard effort against the post. Cahill then leapt to meet Willian's corner with a header that cannoned off the post, further incensing the home crowd.
City was reeling but finished strongly, with Silva denied by Petr Cech from a free kick then sidefooting wide from Kolarov's cross. And in the final seconds, substitute Stevan Jovetic's long-range shot was tipped over by Cech.
But Mourinho and Chelsea finally showed just how City can be stopped.