between 4.5p1 and 4.6p1 the ChallengeResponseAuthentication parameter stopped defaulting to 'yes' and must be explicitly set to work. I suspect this is the result of the Match keyword support that was added - but it should either default correctly or the default sshd_config should be updated to match.
You've reported this against 4.7 however it should have been resolved in that version: - dtucker@cvs.openbsd.org 2007/03/09 05:20:06 [servconf.c sshd.c] Move C/R -> kbdint special case to after the defaults have been loaded, which makes ChallengeResponse default to yes again. This was broken by the Match changes and not fixed properly subsequently. Found by okan at demirmen.com, ok djm@ "please do it" deraadt@ Are you really having problems with 4.7 or did you mean to report it against 4.6?
my apologies - it does in fact work for me in 4.7 (missed this in initial testing)
Close resolved bugs after release.