This is an open-ended question and the right answer is how you answer it, not really the content.
You are trying to convince the interviewer that you are a good investment, will work hard, you're not a risk, you get along well with others and you can come to an agreement on the money. Whatever you answer, make sure it is wrapped around all but the last of the conditions but the last one as that will come at the end of the interview.
A good answer would be that your most challenging project was something that you did that had a big impact on the customer and had an aggressive set of needs attached (low coding time, high skill needed, very fast program requirements, very low cost to build, etc.) combined with a feeling that you had really enjoyed the process. You seek out challenges and are the kind of worker who isn't afraid to take on the most complicated assignments. I would then add to that how you feel about challenging projects as something that allows you to connect to a higher purpose in your career. There will always be assignments that are operational or routine, but the challenging tasks completed successfully are what ultimately make you, your teammates and your employer better off.
Since the hiring manager can assume that you can do the routine tasks, the question about the challenging projects will reveal your level of skill, effort to complete tasks, teamwork, enthusiasm and determination. No answer is perfect or will work for everyone, but as you talk to the interviewer remember that people hire people, not companies hire people. The interviewer is looking to find out if you resonate with what he or she wants. Find out early what they are looking for in the ideal candidate and what the culture is at the company.
If the boss has a work culture of heads-forward, trial by fire and work 50 hour weeks only to go home and work more, then your answer to "What was your most challenging project -- and why?" will need to reflect that you would fit in there. When all else fails, respond in answers that fit the culture and show you focus on fast, accurate and educated results.