Using a 492fb-1 data sample collected near the Υ(4S) resonance with the Belle detector at the KEKB asymmetric-energy e+e- collider, we observe the decay B0→pp̄K*0 with a branching fraction of (1.18-0.25+0.29(stat)±0.11(syst))×10-6. We study the decay dynamics of B0→pp̄K*0 and compare with B+→pp̄K*+. The K*0 meson is found to be almost 100% polarized (with a fraction of (101±13±3)% in the helicity zero state), while the K*+ meson has a (32±17±9)% fraction in the helicity zero state. The direct CP asymmetries for B0→pp̄K*0 and B+→pp̄K*+ are measured to be -0.08±0.20±0.02 and -0.01±0.19±0.02, respectively. In addition, we report improved measurements of the branching fractions B(B+→pp̄K*+)=(3.38-0.60+0.73±0.39)×10-6 and B(B0→pp̄K0)=(2.51-0.29+0.35±0.21)×10-6, which supersede our previous measurements. © 2008 The American Physical Society.