Arsenal looked set to keep the pressure on Manchester United and Chelsea when substitute Samir Nasri broke the deadlock with 10 minutes remaining.
But veteran Blues striker Kevin Phillips scored the 250th goal of his career in injury-time to leave Arsenal in third place, four points off leaders United.
Now Wenger (right) has to try and lift his squad for the quarter-final first leg meeting with Barcelona at the Emirates Stadium on Wednesday.
He said: “Will it be hard to lift the players up for Barcelona? Yes, it is always hard to pick the players up when you get caught like that at the end of a game.
“We are on a run that is very difficult and where we have no room for error at all so the result at Birmingham was a big disappointment.
“It felt like a defeat but the game against Barcelona is in a different competition and we have a few days to recover and prepare.
“I don't know how damaging that result will be in the long term but I think it is a big blow for our title hopes because we were in a position where we had to win all our games.”
Fabregas was being assessed yesterday Arsenal's medical staff after being on the receiving end of what appeared to be a fierce but legitimate challenge from City midfielder Craig Gardner.
The captain was all set to be substituted but then declared himself fit to continue. No free-kick was awarded by referee Howard Webb but Wenger saw it differently. He intimated it was the latest example of Arsenal being on the receiving end of a “bad tackle” after the long term injuries to Eduardo and, most recently, Aaron Ramsey.
He said: “Is Fabregas doubtful for the Champions League? I don't know. He will be assessed. It was a bad tackle, one more. He got tackled at the knee.”
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