For a complete transfer of Posts along with Categories, I think there's just two steps involved. This assumes you're using XML storage (not DB).
1. In the App_Data folder, there's a categories.xml file. Copy the categories from blog2's categories.xml file into blog1's categories.xml file via a text editor. You'll basically be copying four <category> tags into blog1's categories.xml
2. Copy all the XML files in the App_Data\posts folder from blog2 into the same folder of blog1.
After doing these two steps, you'll want to restart blog1 so the changes are detected by BE. It can be restarted by making any change to the web.config file for example (add a space, etc).
I think moving the blog2 categories over to blog1 is necessary since the blog2 posts are tied to those categories. If you don't move the categories over, you'll likely get an error when BE tries to tie the categories in the posts to the categories
in categories.xml and can't find the categories.