Arsenal have won five of their last six games - including a 3-0 win against Villa at the Emirates Stadium last month - and O'Neill knows his side will have their work cut out to halt that rampaging run.
O'Neill, who has injury problems to contend with for the clash with Arsene Wenger's side, said: "We are capable of winning this game.
"But saying that Arsenal are a very fine side and have got themselves back into championship contention and are capable of winning the league.
"I haven't seen Arsenal as being out of contention for the title.
"They are a fine footballing side but when they lost Robin van Persie I thought he would be a major loss.
"But they are scoring goals for fun and are an outstanding attacking side.
"What they have done has not surprised me. It is just the way they have utilised the players so well.
"After losing at Stoke City in the FA Cup last weekend I assume they will be back to their full side against us.
"It will be a great game and I am looking forward to it.If it is anything like the match at Villa Park last season when we should have been four up and instead found ourselves two down and fought back to make it 2-2 it will be a tremendous match."
Villa also gave Arsenal a major test last month and the final 3-0 scoreline did flatter them somewhat.
O'Neill added: "The 3-0 defeat now doesn't really matter. The free kick by Cesc Fabregas was obviously the main issue of the day. It was a great goal for them and it turned the game.
"I think anyone who watched the game would say the result was not a fair reflection of the match.
"But it happened and we now have to try and win ourselves to make amends. It is a game we can win."
Villa's cause will not be helped by the fact that O'Neill's small squad, in Premier League terms, is starting to be hit by injury problems.
Full-back Stephen Warnock, midfielder Nigel Reo-Coker and striker John Carew are all missing through injury and that is a growing headache O'Neill could do without.
"A few weeks ago someone said we had got through a couple of months without having any injuries and that is usually the death knell," said O'Neill.
Influential captain Stiliyan Petrov is struggling with an Achilles problem but he wants to play and O'Neill has hailed the approach and form of the Bulgaria midfielder who also played for him at Celtic before making a £6.5million move to Villa three-and-a-half years ago.
O'Neill said: "He was a very fine player at Celtic.
"My view now is that it was money well spent to get him to Villa as he has exceeded expectations considering the consistency that he has produced for the last two years.
"I think he has thrived on the responsibility and I am delighted for him."