Obviously this is an MGE limitation, not a morrowind engine limitation. Hopefully one day this will be resolved, ive not looked into MGE to solve it myself.
There was a report about "4 GB FIX", letting MGEgui to overcome memory limitations. If you have 4+ GB RAM you can try.
http://www.ntcore.com/4gb_patch.php
Use it on MGEgui.exe.