City enjoyed a regal dominance up until Ilkay Gundogan's 26th-minute opener but Jeffrey Schlupp levelled six minutes later before Townsend turned the contest on its head with an outstanding long-range volley.

Luka Milivojevic increased City's misery and delight at Anfield with a 51st-minute penalty that means Liverpool will celebrate Christmas with a four-point lead at the Premier League summit.

Kevin De Bruyne's overhit cross sailed in five minutes from time but Pep Guardiola's side was unable to undo the damage in the late rally that followed.

Gundogan was involved alongside Bernardo Silva in carving through Palace for Leroy Sane to shoot wastefully into the side-netting in the 10th minute.

The Germany midfielder showed his countryman how it was done when he eased into the box to head home Fabian Delph's searching cross.

Schlupp allowed Gundogan to run off him for the opener but more than atoned by shifting outside a tired Kyle Walker challenge and arrowing a strike into the bottom right corner.

If that finish was impressive, Townsend’s remarkable goal 10 minutes before half-time was something else altogether as he put his left foot sweetly through an audacious volley, leaving Ederson with no chance.

Pep Guardiola introduced City's record goalscorer Sergio Aguero for centre-back Nicolas Otamendi early in the second half but the reshuffle led to confused defending as Townsend headed Aaron Wan-Bissaka's cross against the post.

Walker made a dreadfully rash challenge as Max Meyer sought to retrieve the rebound to concede a penalty and Milivojevic, who had a penalty saved by Ederson in a 0-0 draw at Selhurst Park last season, made no mistake.

City's response was disjointed before Sane cracked the outside of the right post with a 77th-minute free-kick.

De Bruyne's freak goal then set nerves jangling and Aymeric Laporte and Gabriel Jesus spurned free-headed chances for Palace to hold on.

Guardiola's men travel to Leicester City next, a week on from winning a penalty shoot-out in the Carabao Cup quarter-final at King Power Stadium. Palace will return to Selhurst Park for a potentially pivotal clash against Cardiff City.