Michaela Gorman said James Carlo Wilson, 24, otherwise kept quiet when he was struck in Frenchman’s Way, South Shields, in the early hours of March 29, 2016.
Ms Gorman, 25, the sister of Mr Wilson’s former girlfriend Kayleigh Reay, told the hearing his reaction made her think the bullet had missed him.
But moments later she heard him cry out ‘ah’ when has was struck by a second, fatal shot.
Mr Wilson, of Candlish Street, South Shields, died in hospital in Newcastle three days after the incident.
Giving evidence on the fourth day of the Newcastle inquest, she said she was watching him from a window at Ms Reay’s house in Frenchman’s Way, South Shields.
Mr Wilson was pacing from side to side, talking to police on what she took to be a mobile phone on loudspeaker in a pocket.
During the call, she heard him tell officers he had a gun – but did not see the weapon herself.
Of the moment he was shot by an attenuating energy projectile (AEP) - a type of rubber bullet – she said: “He pointed his hand towards them as though he did (have a gun).
“He had been telling police that he had a gun and I was shouting out of the window for him to drop it but he didn’t.
“Just a little giggle but I didn’t hear him say anything. I didn’t know that it had hit him, I thought that he had skipped it.”
The inquest has heard the AEP failed to fell Mr Wilson, who had told police he had a 9mm pistol and planned to shoot officers who approached.
Another police marksman from the same first unit fired a second round from a rifle around five seconds later, the hearing has been told.
Ms Gorman added: “It all happened so quick. I heard him shot, then lying in the road. Then ‘ah’, he was in pain then.”
Of the alleged weapon, she said: “He didn’t have it pointed towards police all the time.”
Cross examined by Sam Faulks, representing Mr Wilson’s family, Ms Gorman said she believed Mr Wilson’s action were a ‘cry for help’.
She added: “He didn’t seem to care, he wasn’t frightened when they were standing in front of him with guns.
“I don’t think that he thought it would go the way it did.”
Also giving evidence, operational firearms officer Sgt Simon O’Neill denied police had provoked the shooting.
Mr Faulks suggested the fact only one armed response unit had reached the scene and confronted Mr Wilson, had limited the police’s options in dealing with him.
He also suggested the officers in the vehicle escalated matters by immediately ordering Mr Wilson to drop his weapon.
Sgt O’Neill, who was leading the operation on the ground but who had yet to reach the incident location, insisted officers had responded appropriately.
He said: “I believe the crew reacted in line with their training and brief.
“The subject, from what I knew at the time, had enough opportunities to understand what options were available to him. They (the police) got nothing back.
“They minimised all other risks and had to react with from less lethal option to lethal option.”
Last week the inquest heard Mr Wilson had spent most of the previous day drinking alcohol with friend Sean McLellan – and may have had a death wish.
In a statement to the court, his father, Carl Wilson, claimed his son wanted to go out in a ‘blaze of glory’ and had deliberately put himself in the firing line so as to ‘commit suicide’.
The hearing continues.