When a target grating is flashed into a larger, surrounding grating, its contrast is perceived to be lower when both gratings are oriented collinearly rather than orthogonally. This effect can be used to dissociate the perceived contrast from the physical contrast of a target grating. We recorded the transient electric potentials and magnetic fields evoked by flashed target gratings and compared them with psychophysical judgements of perceived contrast. Both early (100 ms) and late (150 ms) transients were reduced in amplitude when targets were flashed into a collinear rather than orthogonal surround, thus paralleling the reduction in perceived contrast. Although targets in orthogonal backgrounds required 40% lower physical contrast to match the perceived contrast of collinear targets the amplitudes of electrophysiological transients of matching stimuli were almost identical. Thus, the responses correlated better with perceived than with physical target contrast. This holds especially for the late transient response. Source localisation indicated that the transients in question may originate in primary visual cortex. Our results therefore identify the activity of primary visual cortex as one possible neural correlate of perceived contrast.