We report on the relationship between growth, partitioning of shoot biomass and hydraulic development of Eucalyptus tereticornis Sm. grown in glasshouses for six months. Close coordination of stem vascular capacity and shoot architecture is vital for survival of eucalypts, especially as developing trees are increasingly subjected to spasmodic droughts and rising atmospheric CO₂ levels. Trees were exposed to constant soil moisture deficits in 45 L pots (30–50% below field capacity), while atmospheric CO₂ was raised to 700 μL CO₂ L–1 in matched glasshouses using a hierarchical, multi-factorial design. Enrichment with CO₂ stimulated shoot growth rates for 12–15 weeks in well-watered trees but after six months of CO₂ enrichment, shoot biomasses were not significantly heavier (30% stimulation) in ambient conditions. By contrast, constant drought arrested shoot growth after 20 weeks under ambient conditions, whereas elevated CO₂ sustained growth in drought and ultimately doubled the shoot biomass relative to ambient conditions. These growth responses were achieved through an enhancement of lateral branching up to 8-fold due to CO₂ enrichment. In spite of larger transpiring canopies, CO₂ enrichment also improved the daytime water status of leaves of droughted trees. Stem xylem development was highly regulated, with vessels per unit area and cross sectional area of xylem vessels in stems correlated inversely across all treatments. Furthermore, vessel numbers related to the numbers of leaves on lateral branches, broadly supporting predictions arising from Pipe Model Theory that the area of conducting tissue should correlate with leaf area. Diminished water use of trees in drought coincided with a population of narrower xylem vessels, constraining hydraulic capacity of stems. Commensurate with the positive effects of elevated CO₂ on growth, development and leaf water relations of droughted trees, the capacity for long-distance water transport also increased.