I played fable 1 on xbox and then lost chapters on PC (the only game I've bought twice) but haven't played 2 yet.
The touch mechanic could work well, it works in Ico because of the language barrier and in fable you can't talk which is similar.
I don't think the morphing swords will quite work out though. It sounds like you're just going to get good/evil variations of spikey, blunt edged weapons, unless you set out not to kill any hobbes.
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