Thanks for the suggestions, taazz. Unfortunately the insertion of the quotation marks in the run command had no effect, exactly the same error message.
The other suggestion might be a fallback solution, but I would like to avoid it if I can as it will complicate my backup routines. I am rather confused as to how this error has shown up, since it has been working normally for years. As I am pretty sure that it worked normally when I upgraded to 1.8.0 or one of the 1.8.0 RCs, but not now, it could perhaps be a change in some setting that was introduced with the later versions (I have not been very active lately, so mostly checked out old projects). Or could there have been a silent Windows update in the mean time that has messed things up? the folders under my home folder are fully writable though and I have full privileges, I even tried "run as administrator" without any improvement.
Perhaps I should try a full uninstall and a clean reinstall without using old settings files. It could be interesting to hear though if anyone has success with the run command even if they have spaces in any of the folders in the path of the project folder.
Update while editing: The theory about problems with space in the folder path is not supported. I tried to create a folder 'C:\Lazarus Projects' and placed the project folder under it. Both the build and the run command worked well.
I also copied my whole "LazarusProjects" folder from my home folder to C:\ and that also worked.
Update2: I did a complete uninstall, removed project settings (after backing them up) and did a clean install of 1.8.0- RC1. Did the same with 1.8.0 RC4. Still no success with the run command. It is highly unlikely that I did not check these out previously and had them working. Thus it is highly unlikely that it is related to the Lazarus version. There seems to be some change that has happened to the folder tree under my home directory. Thus I have now reverted back to 1.8.2 with cross compiler and anchor docking support and successfully recompiled Lazarus, using the old settings. I also recreated the project folder under my home directory and copied files back, but no luck. Could there be some additional security has been introduced in a Win7 professional update that prevents an application under the home folder to be launched by another application? Anyone else seeing this?