I'm posting this from Windows Live Writer. It's even better than Word 2007 and a lot better than the Blogger website's own editor. Although, like Word 2007, WLW also does not have a direct support for uploading images to Blogger, you can insert images using Flickr.
Download WLW here: http://get.live.com/betas/writer_betas
To use Flickr, you need to also download the Flickr4Writer plugin here:
Now you'll find "Insert Flickr Image" option on the sidebar of Windows Live Writer. Please note that uploaded photos must be public otherwise you won't be able to find them when searching with the plugin. Sign up for Flickr at http://flickr.com.
To easily upload images to Flickr, you can use the Windows XP's built-in File Publishing Wizard. You must first set it up to show Flickr by running this REG file:
Now you can simply select the files you want to upload, then in the sidebar under "File and Folder Tasks", click "Publish this file (the selected items) to the Web".
I believe this solution would also work in Vista though I have not tried it.
For those with other operating systems (Linux/Mac/Windows 98/XP/2000/Vista), you can find more uploading tools here: http://www.flickr.com/tools/
Of course you can always manually upload pictures by logging into Flickr in your web browser. That's it for now.