To rest in Morrowind for the PC, press the Rest key (T key by default). On the Xbox, press the Back key. Once the Rest button is pressed, a box will appear with a slider bar.

Do people sleep in Morrowind?

In Morrowind NPCs don't level up because, unlike in later games, NPCs don't sleep.

Where can I sleep Seyda Neen?

you can rest anywhere outside the city, also. just by hitting your "Rest" button. as long as no monsters are nearby, you will get a nice, deep rest. if you finish a certain in town quest, you will have access to a house that you "claim" for yourself.