Prepare the page block by gluing the outside edges together and camping until dry. This will keep the outside of the niche together while you work. It's helpful to position your niche against one of the book's covers, but not mandatory. Just make sure your page block is thick enough to contain the items you plan to put inside of it.
Mark out the edges of your niche with the craft knife, cutting through the first few sheets below. Keep making cuts along these lines, removing pages as you go, until you reach your goal depth. Take your time to prevent injury to yourself or the book.
Clean up the edges of the niche with a power drill with a sanding tip. If you plan on putting a door or cover over your niche, this is a good time and tool to carve out a smaller niche along an edge to make it easier to open or lift.
Glue the inside edges of the niche and let dry. Clamping around the niche will help prevent buckling. If that isn't easily accomplished, lay a sheet of wax paper over the niche and weight the entire thing down until dry.
Decorate and fill your niche as desired. Let your creativity flow!