Can you describe an instance from the Satcharitra where Sai Baba demonstrated his ability to know people's innermost thoughts?

Certainly. Chapter 28 recounts the story of a devotee named Laxmichand. While at the masjid, Laxmichand privately thought that Baba's persistent cough might be the result of an 'evil eye.' To his complete astonishment, Sai Baba then spoke aloud, saying, 'It seems someone's evil eye has struck me; Therefore this cough again and again causes distress to my life.' This incident caused Laxmichand to wonder how Baba knew his exact thought, concluding that Baba must dwell in everyone's heart. He then pleaded for Baba's continued grace, his faith deepened by this display of omniscience.