I vote for some Roman blinds in a nice print or stripe. Something that will embrace all the colors you're bringing in. You may want to check out Etsy. When we were doing our bathroom upstairs, I wanted something different for the window and found a woman there who made valances. Her workmanship was fabulous and I was really happy with the transaction. My favorite thing about it is it's more unique so every other house in the area doesn't have the same thing. A lot of the sellers have pricing that's reasonable too and the choices are unlimited. Here is a link that might be useful: custom made Roman Shades

I would go with stenciled roller shades for 2 primary reasons: 1. Very few holes added to the woodwork. 2. Your trim is wonderful. Roller shades will afford you the protection you want, yet also allow you to show off the trim most of the time. http://www.annwallace.com/roller-shades/

You could remodel that hearth and do away with the part near the window :) I like the idea of hanging the panel on the left side of the window and just living with the weird drape over the mantel when they are closed. But I think I would put up a ceiling height valence and do wood blinds. You can change the fabric of the valence as you wish to change the look and the wood blinds are gorgeous and give a room a nice feeling.if you are worried about the height of the blinds then do the top up/down honeycomb ones in a similar color to the walls to make them visually smaller. The window will still be the star of the show and the valence will be the supporting cast that draws the eye.

I have pretty much the same setup as you and have 1 inch blinds. I want to go with something else but with the shallow windows I’m having a hard time.