"I think in football everything is possible," Xhaka told Sky Sports News.
"Manchester City, at the moment, are on a very good run, they're doing very well and others have dropped points -- which they haven't done -- but it's conceivable that they could drop points as well."
City's dominant run has seen them score 40 league goals and concede just seven to open an eight-point lead over second-placed Manchester United but Xhaka says Pep Guardiola's side could slow down and Arsenal must capitalise when they did.
"They might not continue as they have been. But our aim is just to focus on ourselves. We know we need to work and we're convinced that we can compete at the top," Xhaka added.
"I'm a person who thinks realistically but has dreams and fantasies as well. In football, everything is always possible."
Arsenal play FC Cologne in the Europa League on Thursday followed by a trip to seventh-placed Burnley in the league on Sunday.
(Reporting by Aditi Prakash in Bengaluru)
