Although I really think Style 1 is better in principle, in that particular case Style 2 does work pretty well, but I chalk it up to Yoshi's Island peculiar art style.
I tried something similar with other games and it always ended up looking pretty horrible, but in this case I can't honestly object. I wonder if the other backgrounds in the game would look as good though. If you can, please post more example.
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Current projects: Bucky O'Hare (NES), Metal Storm (NES), Clock Tower (SNES), Ristar-The Shooting Star (Gen), Sonic The Hedgehog (Gen), Sonic CD (Sega CD), Mega Man Zero (GBA), Battletoads (NES)