Tried the latest WP1.1 nightly dated Feb 7. When I tried to upload a jpeg file, it works (except for the image resize). I get this error saying:
Filetype not supported. Thumbnail not created.
Yet the image was just a normal .jpg file. Cool feature though -- I think a LOT of users would greatly appreciate some sort of way of easily adding images to their blogs, especially after reading the forums (I know I do!).