Analysts had been looking for a neutral PSBR outcome in July. The figures pushed gilts higher and the improved sentiment gave a further push to equities, with the FT-SE index of 100 leading companies closing at a record high of 3872.9, up 35.5 points on the day.
Dealers ascribed the stock market's strength as much to futures trading, a strong opening on Wall Street and interest rate hopes, but leading investment houses such as Robert Fleming, Societe Generale Strauss Turnbull and Charterhouse Tilney are predicting the Footsie will break the 4,000 barrier by the end of the month.
Central government, local authorities and public corporations repaid pounds 1.66bn of borrowings in July, the first time the national debt has fallen since January.
Markets have been fretting over the Government's apparent inability to control public borrowing, but some economists said the good July figures put the Treasury's summer forecast of pounds 26.9bn for the year back on target.
The July outcome was accompanied by news that June's borrowing requirement has been revised downward by around pounds 200m to pounds 3.48bn, bringing the cumulative total for the year to date to pounds 8.8bn, down from pounds 12.1bn for the same period of 1995/96.
The figures were swollen by the proceeds of the first instalment of the British Energy privatisation, around pounds 600m, and the pounds 200m repayment of a Railtrack debenture. But even stripping those out, tax receipts were strong last month, with VAT returns up 29 per cent.
This confirmed other signs that high street sales are reviving. Both the corporate sectors and private individuals are doing well, judging by the 33 per cent rise in corporation tax and 14 per cent rise in income tax receipts last month.
Adam Cole, economist with brokers HSBC James Capel, said the figures could give the Chancellor scope for perhaps a 1p cut in basic rate taxes in November. "The trend that is emerging now puts [the Treasury] almost bang on target.... Given the receipts coming through in the second half, we could see the final figures coming in as an undershoot."
Cynics might suggest the Treasury had been deliberately cautious in its forecasts to provide a background to justify tax cuts. Mr Cole said: "I think, if anything, they have skewed the risks in that direction. In that connection, today's figures put tax cuts back on the agenda."
However, it was also pointed out that the Government is still over-spending against its official targets.