Now that Loki’s on the throne, the first order of business is to make sure he stays there. He’s already dealt with Thor’s friends back in Asgard - kind of - but now he needs to take care of the other end. So off to Midgard he goes.
Loki’s plan here is to convince Thor not to return. There’s a very complex reasoning behind the story that Loki gives Thor. It’s a complicated lie and it serves a few very specific purposes.
Thor begins by asking for a chance to explain himself. He wants to tell his father that he’s changed. He hasn’t, of course. Not yet. Otherwise he’d have been able to lift Mjolnir, but that’s beside the point.
So Loki begins his lie.
Loki has to get Thor to stop trying to come home. Now, he could have just said “It’s permanent, sorry.” But Thor’s stubborn. He would have kept fighting, kept trying to find some way back to reverse it.
So Loki has to break his spirit. He first insinuates that Odin is dead because of Thor’s actions, knowing that even as Loki tells him…
… that’s exactly what Thor is going to do. The guilt of killing your own father out of grief might be enough to stop some people, but Thor is a pretty resiliant person. A little guilt trip isn’t going to break Thor down. Loki has to destroy his will completely if he wants to keep the throne.
Which is why this is only step one.
Next, Loki plays up his sympathy for Thor’s situation. The message is clear: I’m so sorry. I sympathize. It’s not your fault, Thor, but it’s not mine either.
Which leads into the final stroke of this fabrication. Loki tells Thor that he’s king now, and Thor sees the tiniest bit of silver lining. Maybe Loki can reverse the banishment? Maybe he can come home and mourn for his father with the rest of them?
But Loki has created the perfect scenario to keep Thor on Earth. A treaty with Jotunheim to stop the war, but it’s conditional on Thor staying exiled. It serves two purposes.
First, now there’s a punishment for coming home. If Thor ever did decide to try it, he’d be bringing war back to the kingdom. And, the last time he started a war, as far as he knows, his father died. Quite the deterrent, there.
Secondly, it shows that the kingdom is in capable hands. Loki stopped the war, he negotiated their way back to peace. Thor doesn’t have to worry about his home, because Loki has everything under control.
But Thor is desperate. He doesn’t want to be stuck here! There has to be something that Loki can do. He’s always been the clever one - there’s got to be a loophole or something. Anything.
So Loki delivers the crushing blow.
I feel like this isn’t something Loki wanted to say. The slight hesitation before he gives this reason makes me think this was a last resort. The card he didn’t want to play. He doesn’t want his brother to be unhappy - but Thor wasn’t going to stay without hearing it. And Loki will do what needs to be done to keep the throne. Even if it means hurting Thor.
Finally, Thor gives up. He’s been destroyed almost as thoroughly as Loki was back in the Vault, and he’ll stay where he is. There’s nothing to be done, so he accepts his fate, trying to face it with as much grace as he can muster.
I drift into speculation here, but it’s something I feel is very plausible. I don’t think Loki could have pulled this off if he hadn’t gone through what he had. Sure, he’s always been a trickster, a good planner, and a good liar; but I don’t think he would have been able to ruin Thor - destroy him like this - until he had been destroyed himself. He knows how to break someone down - to hit them in all the places where it really hurts - because he’s been there. He went through it himself. We can see this tactic come back in The Avengers, where he uses a similar emotional attack on Natasha.
Finally, before he goes, he decides to try to lift Mjolnir himself. It’s a small gesture, true, but significant. Even now that he has the throne, he still wants to measure himself against his brother.
But of course, Mjolnir stays put. Loki just doesn’t measure up. He’s not worthy so - glad no one was there to see him fail - he turns away and leaves.