Even though you are using 2007, see if what you are doing differs from the
steps in the article "Mail Merge to Labels with Word XP" on fellow MVP
Graham Mayor's website
athttp://www.gmayor.com/mail_merge_labels_with_word_xp.htm

However, if you are you using a Tablet PC, or possibly using Vista as the
operating system, there is a bug in the Propagate labels routine that should
copy the setup of the label from the first label on the sheet to all of the
other labels on the sheet.

The following macro can be used to overcome that problem:

Macro to overcome the problem with propagation of mail merge field fields
with a label type mail merge when using a Tablet PC and some other Computers
that have Tablet PC Functionality available:

Sub MailMergePropagateLabel()

Dim atable As Table

Dim i As Long, j As Long

Dim source As Cell, target As Cell

Dim myrange As Range

Set atable = ActiveDocument.Tables(1)

Set source = atable.Cell(1, 1)

Set myrange = source.Range

myrange.Collapse wdCollapseStart

ActiveDocument.Fields.Add Range:=myrange, Text:="NEXT", _

PreserveFormatting:=False

source.Range.Copy

For j = 2 To atable.Columns.Count

   Set target = atable.Cell(1, j)

   If target.Range.Fields.Count > 0 Then

       target.Range.Paste

   End If

Next j

For i = 2 To atable.Rows.Count

   For j = 1 To atable.Columns.Count

        Set target = atable.Cell(i, j)

        If target.Range.Fields.Count > 0 Then

             target.Range.Paste

        End If

   Next j

Next i

atable.Cell(1, 1).Range.Fields(1).Delete

End Sub

It is suggested that you put this code into a template that you save in the
Word Startup folder so that it becomes an add-in and will be available
whenever you need it.  As the macro has the same name as the Word Command
that is supposed to do the job, this macro will run when the Update Labels
button is used when setting up the mail merge label main document.