This takes part in mission 9 "The Sleeping Village"
You cannot harm the villagers. The only enemies that you can attack are the boiler guards that appear later in the level in a cutscene.
You will need to do the level without killing any villagers in order to get the chalice, however, it is important to note that ANY damage on a villager will void this trophy, even if it doesn't kill them.
It is mostly simple to avoid causing any damage to the villagers, with the following 2 exceptions;
1) In the Library, break the wall quickly so that the enemy isn't close enough to take splash dmg.
2) In the house where you get the Earth Rune, you need to break a barrel to get into the rune. Using weapons is likely to hit the enemy, so I found it easier to shield bash the barrel and get it that way