The 1989 visit to Arsenal wasn't the first time City wore yellow. There's a picture of Denis Law in the first edition of Manchester - The Greatest City wearing a kit with yellow shirts, white shorts and yellow socks with maroon trim in a game at Leeds in 1960-ish. This would have been before Revie took over at Leeds and changed the strip to all white, so I presume they were in blue.
Anyway, the story I heard about that kit at Arsenal was that City had worn the away kit for that season, the one with the maroon and white stripes, away to Coventry, who also had a kit with white stripes that season. Apparently, the ref was unhappy that both kits had a lot of white and we were told we'd need a third kit when we played Sheffield Wednesday and QPR. The yellow at Arsenal was a prototype that was used as an experiment but was so unpopular it was never seen again. Instead, we got an all maroon kit towards the end of the season and that, with a different collar, was then used as the second kit for the next two years.
As noted above, we've had yellow kits since then. The most recent was in 2005/6.
Here, with a nod to the superb mcfcvideos youtube page, are brief highlights of the game at Coventry that supposedly caused the confusion:
[youtube]http://www.youtube.com/watch?v=j6_660y_fXA[/youtube]