After further investigation the copy/paste solution doesn't seem to work either with the latest BD. The images appear in BD however when you then try and create the lrf file the images are not embedded in the output file.
This failed under Vista and my XP Virtual machine (ok with Office 2007). I'm happy to think there are issues with Vista but the XP version shouldn't have an problems.
I then reverted back to the 1st March 2007 release and this appears to work fine even when copying the images into word doc and then loading into BD.
So it seems there is an issue with file/image linking with the latest release of BD - assuming the one I'm running (12th April 2007) is the latest release?