Running from an external USB HDD is fine, a nice method personally for me as i get 24fps playback which I think makes a difference when implemented on my TV (especially for fast-panning shots or action scenes).
Yes, running the mkv through mkv2vob will do one of two things :
1. It'll just change the header of the mkv file so that it comes out as a playable mpg (or whatever file extension you've chosen), whilst patching the sound (if DTS) to trick the PS3 into playing back DTS sound (as you can't get DTS playback via a file, without this trick), or you can have it convert the DTS to AC3.
2. If it needs to, mkv2vob will set about actually transcoding the file. This can be due to a number of issues in the source mkv itself. If it's a 1080p mkv, then dependent on your pc spec (and depending on the codec you use, x264 being the best but the slowest), this may take a number of hours to do - this VERY rarely happens with a 720p mkv, but is more frequent (30-50%) on 1080p mkv's.