If you click on the 'Flight+Hotel' part on the main ba.com page and then go through with the process then you cannot upgrade using miles. It is classed as a Travel Agent booking.

However if you book + MFU your flights first as a normal flight only booking, then once you have a booking reference number you can go into your (MMB)booking to the relevant bit where it says 'Book a Hotel'

This then gives a seperate reservation booking reference number. You can also have this non-flight part link/showing up in your flight only booking. Hope this makes sense and can all be done on. ba.com!

The advantage with booking both together at the same time on the flight +hotel bit is that you can save a bit of money and IIRC you get 10,000 BA miles with some 'holidays' and can save about 10% off the total price.

I usually book my flights and hotels seperately and have done this previously and no problems at all.