CSS defined in library is not included, but theme works
Finally it seems to have been fixed. I re-created the same template again under a new name. Checked the diff of theme.info.yml and theme.libraries.yml files - only difference is the name. The new template has all the same functionality the previous had and is 1-to-1 copy except for the name. So only thing I can think of is that while playing with the template something has broken and left some residue in the database that prevented the theme from functioning properly ever again.

Thanks everyone who tried to help!