I'm sorry you're dealing with this, as you really don't need any drama right now. But, I think you were right to be completely honest with her. You shouldn't feel terrible. Tough love is probably the best for her. She feels like you're excluding her from your wedding spitefully and she fails to look at herself for blame or to realize that she can't live her life in comparison to yours. DirtyMartini is right that there are probably some emotional issues that she's dealt with since you two were kids and it's always been a competition for her. She puts you down to make herself feel better.
My sister used to do the same thing, but I don't let her anymore. (I'm the oldest and she's the youngest with 2 brothers in between us.) When I moved out and got serious with my now DH, she had a hard time handling my happiness. She found every little thing she could think of to find fault in him. I finally called her out on it and told her to back off and not to dump her emotional issues on me. Our lives aren't a competition. It took her a little while to talk to me again and when she did, she was a better person. She realized that the whole world doesn't revolve around her and that she needs to work to better her own life, not to compare her life to mine. We get along much better now, although she still craves the center of attention. We just deal with it better now. When I started wedding planning, I was worried that she'd get this way again, but she really surprised me. She stepped it up and was an excellent MOH. (all of my girls were MOHs) But if we hadn't worked through all of this, she wouldn't have been in the wedding.
I'd give yourself some time to think about things. If you've made a decision not to include her in your wedding, then stand by your decision and always be honest when she questions your decision. If she's only going to put you down in a weak attempt to boost her own self esteem, then you don't need her around you on your wedding day. If you have some time to work some of these issues out before then, then it's never a bad idea to try. Your MOH's suggestion of letting her do a reading is a great idea, but definately wait a while until this blows over.
Sorry this got long. Good luck!