So let’s say Daisy equips it - her sanity goes form a max of 9 down to 7.

Then over the scenario she ends up taking 7 horror. St Huberts key activates and she discards it, and heals 2 horror.

Does the healing horror part mean she goes back to having a sanity cap of 9 with 7 horror on her? Or does she have a cap of 9 with 5 horror on her?

I don’t get it.

The latter. She loses the lowered cap and also heals 2.

The danger is that if something makes you discard the key in some other manner, that healing does not trigger and it is a very expensive card over the rosary if it does not.