Future climatic scenarios forecast increasingly frequent droughts that will pose substantial consequences on tree mortality. In light of this, drought-tolerant eucalypts have been propagated, however, the severity of these conditions will invoke adaptive responses, impacting the commercially valuable wood properties. To determine what mechanisms govern the wood anatomical adaptive response, highly controlled drought experiments were conducted in E. grandis, with the tree physiology and transcriptome closely monitored. In response to water deficit, E. grandis displays an isohydric stomatal response to conserve water and enable stem growth to continue, albeit at a reduced rate. Maintaining gaseous exchange is likely a critical short-term response that drives the formation of hydraulically-safer xylem. For instance, the development of significantly smaller fibers and vessels was found to increase cellular density, thereby promoting drought tolerance through improved functional redundancy, as well as implosion and cavitation resistance. The transcriptome was explored to identify the molecular mechanisms responsible for controlling xylem cell size during prolonged water deficit. Downregulation of genes associated with cell wall remodelling and the biosynthesis of cellulose, hemicellulose, and pectin appeared to coincide with a reduction in cellular enlargement during drought. Furthermore, transcript levels of NAC and MYB transcription factors, vital for cell wall component biosynthesis, were reduced, while those linked to lignification increased. The upregulation of EgCAD and various peroxidases under water deficit did not correlate with an increased lignin composition. However, with the elevated cellular density, a higher lignin content per xylem cross-sectional area was observed, potentially enhancing hydraulic safety. These results support the requirement for higher density, drought-adapted wood as a long-term adaptive response in E. grandis, which is largely influenced by the isohydric stomatal response coupled with cellular expansion-related molecular processes.