A smart finish from Panayiotou restored Leicester’s lead just six minutes later as City looked destined to win the tie in normal time, but Jose Angel Pozo burst through and slotted in with just six minutes to go to make it 2-2.
Extra-time followed, and when Manu Garcia found space in the box, he capitalised, placing an effort beyond Adam Smith to send his side into the final of the competition.
Heading into the tie, Steve Beaglehole’s outfit had lost just once in their last 12 games in all competitions – that defeat coming against Man City at the same venue earlier this month.
City’s route to the semi-finals hadn’t been an easy one, but they dominated in the group stages, winning all three of their group fixtures against Schalke, Benfica and Man City before setting up a quarter-final tie with Everton.
That proved to be their toughest test of the competition so far. The fixture finished 2-2 after extra-time thanks to Panayiotou’s brace before goalkeeper Smith saved two spot-kicks to ensure Leicester won 4-3 on penalties.
Man City were also forced to extra-time in their quarter-final tie with Celtic. After a goalless 120 minutes, the Citizens eventually won 5-3 on penalties to book their spot in the last four.
A good spell of early pressure from the Foxes forced goalkeeper Angus Gunn into conceding an early corner. Jack Barmby delivered into Joe Davis, who side-footed just wide with six minutes gone.
Just a minute later Panayiotou stabbed Simonas Stankevicius’ pin-point cross just wide from six yards. Davis was then on hand at the other end to turn away Ashley Smith-Brown’s cross from the left as the hosts started to gain a foothold in the game.
City had two chances to take the lead on the half-hour mark. First, Jak McCourt hit a half-volley just wide, before Panayiotou dragged a low effort across goal.
A dominant first half performance from Leicester eventually led to an opening goal. Panayiotou took Dodoo’s well-weighted cross first time, hammering in a sweet volley from the edge of the box - 1-0 to the Foxes at the break.
Man City improved vastly in the second period, and following a good spell of possession, they found themselves level as substitute Iheanacho raced through before side-footing past Smith to make it 1-1.
But the Citizens’ lead didn’t last long. The lively Panayiotou turned on the edge of the box before firing in low past Gunn to edge his side back in front.
Stankevicius then forced a fine point-blank save out of Gunn before Davis nodded the resulting corner wide as City looked to extend their advantage.
Man City pushed for an equaliser, but Smith was twice on hand to halt goalscorer Iheanacho and keep his side’s one-goal lead intact.
But just moments later, the Citizens were level. Pozo, who looked a threat all game, collected a neat through-ball before placing his effort past Smith with six minutes to play, forcing the fixture to extra-time.
Chances were few and far between – Panayiotou had half a chance on 98 minutes, only to see his shot blocked by Ellis Plummer.
Despite a spirited performance from Beaglehole’s side, it was Man City who would book their place in the final as substitute Garcia found the back of the net with 107 minutes on the clock.
While Man City will go on to face Porto in the final of the competition, City’s Under-21s now turn their attentions to the Barclays U21 Premier League, where they next face a testing trip to Liverpool on Monday 4 May (4.15pm kick-off).
MAN CITY: Gunn, Horsfield (Angelino 46), Evans, Plummer, Smith-Brown, Glendon (c) (Garcia 77), Intima (Iheanacho 46), Ntcham, Pozo, Byrne, Barker
SUBS NOT USED: Maffeo, O’Brien, Nemane, Celina
GOALS: Iheanacho 58, Pozo 84, Garcia 107
CITY: Smith, Pearson (c), Chilwell, McCourt, Davis (Scott 93), Sesay, Dodoo (Kennedy 83), Rowley (Dawson 61), Stankevicius, Panayiotou, Barmby
SUBS NOT USED: Maddison, Miles
GOALS: Panayiotou 34, 64
REFEREE: Robert Massey-Ellis