The Gunners meet Real Madrid at the Santiago Bernabeu for their quarterfinal second-leg defending a 3-0 aggregate lead.
Reflecting on last week's result, Pennant told Tribalfootball.com: "Listen, if they knock out Real Madrid, any team that knocks out Real Madrid are in the conversation to win the Champions League.
"They're the giant of the competition. They're the juggernaut, David versus Goliath. So if they get through this tie, then 100% they can win this league. For me, though, I would say PSG are favourites, but followed close by Arsenal and Barcelona. So it's all to play for. It's tight."
"Real Madrid could not play any worse"
Pennant concedes the first-leg performance from both teams surprised him. Declan Rice dominated the game, scoring twice from direct free-kicks, with Spain international Mikel Merino also getting on the scoresheet.
Pennant, who had a year in Spain with Real Zaragoza, admits Real fell well short of their usual standards on the night.
He continued: "They (Arsenal) surprised me, but Real Madrid flattered to deceive.
"They were bad. Real Madrid cannot play any worse than that. I've never seen them play that bad. But on the flip side, you've got to give it to Arsenal.
"They made Real Madrid play bad. And no one saw that scoreline coming. No one at all. Especially with the injuries that Arsenal had. Gabriel, then (Jakub) Kiwior coming in. You can think (Kylian) Mbappe, Vinicius Jr, Rodrigo. They're going to have a field day.
"But no, they had a game plan. They stuck to it. It worked. And yeah, two great set pieces. The late goal in the end as well."
On manager Mikel Arteta's approach to tonight's second-leg, Pennant would like to see Arsenal attack Real Madrid, despite the scoreline. Indeed, he says the Gunners cannot afford to simply defend what they have.
"Put them on the back foot"
He explained, "I think they're going to have to play the same way. I think if you sit back at the Bernabeu and let Real Madrid come on top of you and attack you, that's when they're at their best. That's when they will punish you. They will find gaps. They will make things happen.
"But if you put Real Madrid on the back foot, you attack Real Madrid, you limit their attacks, then that's what Arsenal are going to have to do.
"Then if Arsenal score a goal, then you could say the tie is over. But you don't want to sit back, draw on the pressure. But if Real Madrid score an early goal and then a second, then the tie is flipped on its head."
- Jermaine Pennant was speaking to Tribalfootball on behalf of Makthavare