Senior judges have ruled that a leading Islamic political activist is free to stay in Britain despite having given a sermon in which he invoked the antisemitic blood libel.

Sheikh Raed Salah, the leader of the northern branch of the Islamic Movement in Israel, this week won his appeal against a deportation order imposed last year, despite the judges' acceptance that his comments would "offend and distress Israeli Jews and the wider Jewish community".

At the centre of Sheikh Salah's case was his denial that in a 2007 sermon in East Jerusalem his remarks on children's blood being used to bake "holy bread" were references to the blood libel against Jews.

But the tribunal judges ruled that his claims were "wholly unpersuasive" and agreed that Home Secretary Theresa May was right to consider the sermon when deciding whether to ban Sheikh Salah from Britain.

In the decision, Upper Immigration Tribunal vice-president Mr Justice Ockelton said: "We do not find this comment could be taken to be anything other than a reference to the blood libel against Jews."

However, Sheikh Salah's appeal succeeded on all grounds after the judges concluded that ultimately Mrs May had been "misled", had "acted under a misapprehension of the facts" and had shown "disproportionate interference" when deciding to ban him from Britain.

The Home Office said it was "disappointed" by the tribunal's decision and would consider appealing.

Sheikh Salah arrived in Britain last June after border officials made a series of mistakes that allowed him to enter through Heathrow Airport despite being on an exclusion list.

He was detained in his London hotel on June 28, hours after addressing a meeting in Leicester and the day before he was due to speak at Parliament. He was later described in the House of Commons as having "a history of virulent antisemitism".

Three weeks later he was released on strict bail conditions while awaiting his full deportation hearing, which he subsequently lost last October. His appeal against that ruling was heard earlier this year, with the judges' ruling sent to Sheikh Salah's lawyers last Thursday and made public two days later.

The judges recognised the offensive nature of Sheikh Salah's 2007 sermon - for which he was charged with incitement to racism and violence by an Israeli magistrates' court the following year - and a 2002 poem he had written which referred to oppressors as "monkeys and losers". But they ruled that the issues were "not at the heart of the appellant's message" and that "it is not easy to see that any reasonable observer would associate the appellant with them in any general sense".

They said it was "unclear" whether funds he raised for Hamas - an offence for which he had been convicted in Israel in 2003 - had benefitted the terrorist organisation's political or military wings.

The judges ruled that assisting charitable organisations which support Hamas politically is not a criminal offence in Britain, and that the Israeli conviction could not count against him. In fact, since 2003 Britain has signed up to the EU's financial sanctions on all of Hamas's operations, meaning Sheikh Salah's actions would now be regarded as illegal in this country.

Ruling in the father-of-six's favour, Mr Ockelton concluded: "Most importantly, [the Secretary of State] was misled as to the terms of the poem written by the appellant, a matter on which there is now no room for dispute. The matters... are in essence confined to words on one day, that are not shown to have caused any difficulty at the time or since.

"There is no evidence that the danger perceived by the Secretary of State is perceived by any of the other countries where the appellant has been, nor save for the very tardy indictment, is there any evidence that even Israel sees the danger."

Sheikh Salah's presence in Britain had "caused no difficulty of any sort", the judges found.

The role of the Community Security Trust has been questioned by Sheikh Salah's lawyers and supporters throughout the case, after it emerged that Ms May's private secretary asked her what could be done to stop the activist appearing in Parliament just 17 minutes after receiving a report on him written by the CST.

The charity confirmed this week that it had provided the information after being asked to do so by the Home Office. CST had warned government officials that Sheikh Salah could have a "radicalising impact" on British audiences, and provided the Home Office with an original copy of the 2002 poem in Arabic and with English translations. It also provided a copy of the 2007 speech.

Border Agency officials told Ms May that evidence existed to allow her to exclude Sheikh Salah for "unacceptable behaviour" but warned that the disputed evidence might subsequently lead to a legal challenge. The Border Agency later admitted that the decision to ban him had been "very finely balanced".

CST has repeatedly defended itself against accusations - including those made in the Guardian - that it had knowingly misled Ms May.

A CST spokesman said: "CST was contacted by the Home Office to provide information relevant to Sheikh Raed Salah's deportation on the grounds of his presence not being conducive to the public good. CST provided information, in good faith, exactly as our community would expect us to.

"CST stands by its actions and notes, in particular, that the tribunal recognised that Sheikh Salah's intemperate expression could offend and distress the Jewish community.

"We trust that the Home Office will appeal this decision, which threatens to significantly undermine the government's Prevent anti-extremism policy."

Sheikh Salah's solicitor, Tayab Ali, said: "The tribunal had all the facts before it and was able to look behind what we have always argued was a misguided attempt to silence a prominent voice of the Palestinian people.

"There are some very important questions still left to be answered. We need to understand how the Secretary of State allowed herself to exercise such bad judgment and why she thought it was appropriate to rely so heavily on a single organisation, the CST, when making these decisions."

He said Ms May must "recognise her mistakes" and "treat Sheikh Salah with the respect a politician of his standing deserves".

It is thought Sheikh Salah may now attempt to bring legal action against groups and individuals whom he argues attributed fabricated comments to him in what he sees as a deliberate attempt to mislead the Home Secretary.

His supporters include Ismail Patel, chair of the Friends of Al-Aqsa group, who claimed the court's decision was a "victory for those who believe in freedom of speech and who support the Palestinian struggle for freedom from occupation".

Sarah Colborne, director of the Palestine Solidarity Campaign, said the government had acted "shamefully".

She said: "I trust that there will be a serious attempt by the British government to rely in the future on accurate evidence rather than inaccurate anti-Palestinian propaganda against someone who has a history of opposing Israel's crimes and violations of international law."