I've never heard of a 2 year old masturbating...but nonetheless the girl sounds extrememly disturbed. Worse yet, you have clearly stated her father is doing nothign about it.
From my perspective, i would place this girl for psych eval first and in counciling second. BUT if dad will not do anything...and for the fact its relaly up to him to place her in couciling and have her phsych evaluated....but seeign how he acts with it, chances are he wont do anything to help his daughter.
Knowing how this man handles his daughter and the situations, i would advise you to run.
I know many will also give you the advice to stay and work with this girl. But the fact of hte matter is , is that you are not her mom, have no legal right to any decisions with her and if her dad wont do anything but shrug his shoulders, your first duty as a mother is to protect the child you have and the one coming.And if leaving him will protect your unborn and the son you have against his extremely twisted daughter and his lack of parenting, it would be for the benefit of your sanity and your childrens safety.
Bottom line: PROTECT YOUR CHILDREN. IF your boyfriend here is not tkaing care of the daughter he has now, chances are he wont protect the next child he has....so regardless of how much you love him, wont mean anything in the end if both your children are harmed because of his lack of parenting. Its his duty as a father to take care of this little girl who you have described as having serious issues.
Where is her mother? Does this girl live with you or comes to visit.?
If she visits, then dad can visit her outside the home should you choose to stay with this man. If he has full custody, sorry i would tell him either he fix his daughter or you leave or she does....either way as long as this little girl is a danger to your children i wouldn't let her come near them from a mile!
How old is she now? 4 or 5 ?

Honestly, I'd consider therapy for your step daughter. I think her behavior goes beyond just a misbehaved child. Would your husband be willing to get her professional help?
~Bookgirl~

Young children masturbate for the same reason that older children (and adults) do: It feels good! Bodily exploration is part of growing up.

Right now, your child is learning to run, jump, throw, pump a swing, draw, and (possibly) use the toilet. She's likely to be just as curious about her genitals as she is about her fingers, toes, and belly button — and if she's recently switched from diapers to underpants, she may be able to get to them for the first time.

"When parents see this kind of exploration, they wonder, 'Is this normal?'" "The answer is yes, it's normal. You don't need to be concerned about it."

What to do about masturbation
Don't panic. Although the idea of your 2-year-old touching her genitals may make you uncomfortable, remind yourself that masturbation is a completely normal thing to do. It won't cause any physical ills, pose any health risks, or turn your child into a sex maniac. Masturbation in children isn't sexual (as it is for adults) because toddlers don't know what sex is. And while explicit sex play in older children is often a tip-off to sexual abuse or exposure to inappropriate sexual material, this is unlikely to be the case with 2-year-olds, who don't yet possess the imaginative skills for this kind of role adoption. (A 2-year-old who's been sexually abused is more likely to become withdrawn or suddenly have trouble sleeping than she is to start compulsively masturbating.) That said, a 2-year-old masturbates because the feelings it brings can be as pleasurable for her as they are for an adult. "A child this age may even masturbate to orgasm," "complete with panting, red face, and a big sigh at the end. But it's absolutely not something to be worried about."

Ignore it. You may have already told your 2-year-old that some parts of her body are private, and that no one but her, her parents, and her doctor may touch them. Many parents attempt to explain privacy during the preschool years as a way to head off sexual abuse, and it seems logical to extend this concept to masturbation. You might suggest to your child, for instance, that touching herself is something best done behind closed doors. Unfortunately, this message may not sink in. "Privacy means nothing to a child before the age of about 3 — it's just not a meaningful concept," And, she adds, "A 2-year-old by nature is looking to push buttons — so if you start drawing attention to this behavior, you'll probably just cause her to do it more." Your best bet, then, is simply to look the other way.

Distract her. Even though you know that it's normal and that lots of kids do it, you'll probably still be embarrassed if your child starts touching herself in front of company. If you can't ignore the behavior or laugh it off, try to distract her. To a child this age, masturbation is a lot like picking her nose — she does it because it's there, because she's bored, and because her hands are free. If your child's fingers start to stray at inopportune moments (in front of your in-laws, for example), give her a distracting plaything (such as a squeaky toy) or invite her to do a puzzle, play with blocks, or toss a ball around — anything that keeps her hands out of her pants.

Look to yourself. Believe it or not, your own reaction to masturbation may pose the greatest danger to your child's psyche. If she's made to feel guilty for exploring her body or told that what she's doing is dirty, naughty, or disgusting, she may forever associate sexual or pleasurable feelings with guilt and shame. "If you're really bothered by masturbation," "it says more about what you learned growing up than it does about your child. Lots of people grow up with conflicting feelings about sex, and finding a place where you can talk these feelings through with other adults will help you handle these issues now and in the future."

Your SD needs some help. You need to get her to a counselor, Pronto! The way she is acting out is screaming for professional help.

Also, it sounds like you are overwhelmed. Is there Anyone who you trust to watch the kids - even for two hours - just to give you a break. Maybe, MIL or your mom? You would be amazed by what a good bubble bath can do!!

Sometimes problems seem larger than what they are until you step back and look at them. You need to focus on a plan. That can not happen until you get Less stressed.

I suggest getting a counselor for your SD as your first step. Do you have health ins that will pay for it? Or are there free clinics in you area that can put you in touch with a licensed psychologist?

Also, Please use periods in your responses.

For such a young child she is very aware of such sexually explicit actions. She has seen this done or maybe has had it doen to her? Has anyone had her examined for any type of sexual abuse? has anyone questioned the bio mom as to why her daughter may be doing these things? Like everyone is saying get this little girl help ASAP...the more you wait the more damage thats going to be done.
" Faith is a bird that feels dawn breaking and sings while it's still dark"-R.Tagore

I agree with Purpleflower. Her behaviour is sending out major red flags for sexual abuse. Can you think of anyone who might have molested her? Has she ever been in a situation where she may be abused, like a with a family friend or BM's boyfriend? This little girl needs intervention and therapy right away.

If your DH is the custodial parent, it's his job to make sure she gets some help. Some might disagree with me here, but it's my opinion that as the custodial step-mom, you have a moral obligation to this child. She needs help! Her behaviours are just going to get worse, especially with your anger towards her.

You've got a long road ahead of you with this little girl but there is hope for her, and for your family, if you get the help you need. Take her to a therapist as soon as you can. Try to see her as a little girl who is acting out her pain and try to contain your temper. I'll say it again, she needs help!