Sorry about your MIL. And congratulations on your pregnancy!
I really like the Debbie Bliss baby books. How proficient is your MIL? The one for beginners is really basic (though it does have some nice things in)
I have the Baby Knits Book and have used it a lot. It's good as it's got a good range of patterns from very simple, to more complicated heirloom type patterns.
I suggest you get your MIL a book and ask her to choose a pattern, then go and buy the yarn it suggests. If you go to a decent yarn shop, they should be able to help you find a suitable yarn if the one called for in the pattern isn't available. Or come back here and ask!
My favourite yarns for baby things are Debbie Bliss Cashmerino Baby (lovely, but pricey), Sirdar Snuggly (cheap acrylic but very soft and hardwearing and comes in a good range of colours, not just baby pastels) and Rowan Wool Cotton (again not cheap but really nice to knit with and wears very well)
Good luck, it's a lovely idea!