He knows I'm here, might as well give up the charade.
Walk out of the oak, and and tell him to stay away and leave me be. Find another place to rest. Keep an eye on the dog. Club him if the owner decides to let him loose on me. It would be his fault for not heeding my warning.
-1, he already blew the whistle, it is too late for that. Even if we can get rid of him easily enough, he has some backup incoming. If he is part of a militia, he is probably one of Chancellor Ganvor's conscripts. Our position would be best if he didn't know we are back up yet, but it looks like our cover is blown. We could try to either let him live in a way that made it look like he made up the "Ghost Story" of seeing us (Which is difficult, if not impossible), or wipe out the entire militia section to prevent word from getting out.
The others are probably too close to do anything that takes more then a few minutes of time, and likely have at least one dog among them. Even if we let him live and escape, the dog would have our scent trail and could track us. Even if he is terrified now, there is no doubt that having his buddies near him would calm him down enough to be a decent threat.
In the end, he left us no choice. We must kill him and take his blade, before the others arrive. We can then face the section with the sword, lessening our disadvantage. This is war now. This man is a soldier. And enemy soldier.