I was thinking about this thread and realized that one of the people my DD's father cheated on me with has the same name as my stepdaughter (Michaela, so not a supercommon name, but not Mergatroyd either). I was devastated by his cheating, since he cheated when I was pregnant and forced me into being a single mother, something I was not at all happy about. It isn't that the cheating did not affect me or anger me - it absolutely did. It isn't that I forgot the person's name - I haven't.
But, I have never connected this until now because, to me, one has absolutely nothing to do with the other. I do not think about my ex or the person he cheated on me with when thinking about my stepdaughter. I think for some people (like me) it isn't natural to make the connection that the friend in the OP seems to expect her sister to make on her behalf.
I think this is a very important point. I don't believe "most people" would feel one way or the other, but I do think people have radically different wiring when it comes to these type of intuitive, emotional connections. You can see it right here on this thread.
There are people to whom it would never occur that these two things are remotely connected. And there are people who immediately resonate to the associations with the name. Problem is, these reactions are so innate that they seem "obvious" and "natural". When they are neither obvious nor natural to people who are wired the other way.
To me, it makes sense to work from principle. Is the sister doing something rude or unfair in naming her daughter Sarah? No.
Would it be rude or unfair for friend to hold sister's baby name "hostage" to her hurt feelings? I think, yes.
So what it comes down to is, does Friend trust her Sister that this is not some intentional dig? If she trusts her sister's intentions, I think the right thing to do is process this out of Sister's hearing.