The Citizens survived the early dismissal of goalkeeper Ederson for a professional foul on Diogo Jota to take a two-goal lead through Raheem Sterling but could not hold on as Nuno Esperito Santo’s men mounted a spirited fightback with three second half goals to take maximum points.
The defeat means City failed to climb above Leicester into second place, and are now 14 points behind leaders Liverpool, who have a game in hand against struggling West Ham United.
Guardiola’s men have now lost more league games this term than the entirety of last season’s title triumph.
Asked if the title race is over, Guardiola told BBC Radio 5 Live: "The advantage is too big, yes."
"It's unrealistic to think about Liverpool, we think about Leicester," Guardiola added.
"We have the chance to recover second place. I know the quality of my team but that's the situation."
Winger Bernardo Silva added: "It is a really bad situation for us. A frustrating first half of the season. Nobody expected us to be this far away from Liverpool at this halfway point.
"We have to continue now. We know that winning the title is very complicated. I wouldn't say impossible but very difficult."
With the games coming thick and fast over the festive period, Manchester City are back in action with a home game against Sheffield United on Sunday.
