Police have been told to “reflect upon the community impact” on Manchester’s “large Muslim population” caused by their investigation into last year’s attack in the city, where children and their parents were massacred by a local Muslim extremist.

Max Hill QC, the independent reviewer of terrorism legislation, revealed that at least one local Muslim woman had been paid compensation and claimed many had been “inconvenienced if not traumatised” by the manhunt for suspects linked to the Manchester arena attack.

Twenty-three people were killed, including the attacker, and 139 were wounded, more than half of them children, when a suicide bomber struck a pop concert in the arena in May last year.

The killer was later revealed as Salman Abedi, 22, from a prominent family in the city’s Libyan asylum seeker community with strong links to the local Didsbury Mosque, where his father sometimes led the call to prayer.

The mosque had hosted sermons where preachers allegedly called for “armed jihad” and the mosque aimed to spread Salafism, a hard-line Islamic school of thought also followed by al-Qaeda and Islamic State.

In his annual report on the operation of the terrorist acts in 2017, Hill praised the police for the “thoroughness and rigour of an investigation” as they hunted for suspects after the attack.

He also revealed the operation “involved collateral damage so as to necessitate the payment of compensation to one arrested person”.

Specifically, a woman was arrested and her property searched because she was living next to a home that was linked to the attack. She was said to have been in the “wrong place at the wrong time”.

“This was a dynamic and urgent investigation involving multiple premises,” Hill said. “There were legitimate public safety issues; Jtac [Joint Terrorism Analysis Centre] had increased the national threat level to critical in the days after the attack.

“However, it is important to avoid the collateral damage [the woman] experienced, and this has been accepted as a learning outcome for SIOs [senior investigating officers] and police teams in future.”

He said “police should consider and reflect upon the community impact of a large-scale investigation, centring as it did on particular areas of Manchester with a large Muslim population.

“Good community policing, as well as good counterterrorism policing, demands that real efforts are made to work within and with local communities, where many blameless residents will have been inconvenienced if not traumatised by the regular appearance of police search and arrest teams on their street or in their home.”

Also in the report, Hill claims 11 arrests at the home address of Islamist London Bridge attacker Khuram Butt on the day of the killings were “difficult to justify”, adding: “None of those arrested were charged in relation to the London Bridge attack.”

Eight people were killed and 48 were injured in the vehicle-ramming and stabbing rampage in June 2017.

“It must be remembered that any arrest requires reasonable grounds to suspect in relation to an individual, rather than a general scenario presented to officers on entry to premises,” Hill said.

However “there were multiple considerations here, including the unknown risk of a further attack” and “the question of whether any of those arrested may have had prior knowledge of the principal attack”.